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Price and Income Elasticity Overview

Jul 14, 2025

Overview

The lecture covers the Total Expenditure Method and Point/Geometric Method for measuring price elasticity of demand, factors affecting elasticity, and introduces income and cross elasticity including their types and formulas.

Expenditure (Total Outlay) Method

  • Measures price elasticity by observing changes in total expenditure due to price changes.
  • If price falls and total expenditure remains unchanged, elasticity (ED) = 1 (unitary).
  • If price falls and total expenditure increases, ED > 1 (elastic).
  • If price falls and total expenditure decreases, ED < 1 (inelastic).
  • When price rises, these relationships reverse.
  • Total expenditure is calculated as Price ร— Quantity.

Point/Geometric Method

  • Used for finding elasticity at a specific point on a demand curve.
  • Formula: Elasticity at a point = lower segment of demand curve / upper segment of demand curve.
  • On a linear demand curve:
    • At midpoint, ED = 1.
    • At lower end, ED = 0 (perfectly inelastic).
    • At upper end, ED = โˆž (perfectly elastic).
  • On a non-linear curve, draw a tangent at the point and use the segment formula.

Numerical Example (Elasticity Calculation)

  • Use the formula: ED = (ฮ”Q/ฮ”P) ร— (P/Q).
  • Substitute values to calculate elasticity and interpret the result (e.g., ED > 1 is elastic).

Factors Affecting Price Elasticity of Demand

  • Availability of substitutes: More substitutes = higher elasticity.
  • Nature of commodity: Necessities = inelastic; luxuries = elastic.
  • Proportion of income spent: Larger share of income = more elastic.
  • Number of uses: More uses = more elastic demand.
  • Time period: Demand is more elastic in the long run.
  • Possibility of postponement: If consumption can be postponed, demand is elastic.
  • Price range: Very cheap or expensive goods tend to have inelastic demand.
  • Consumer habits: Habitual goods have inelastic demand.
  • Income levels: Higher income, lower elasticity.

Income Elasticity of Demand

  • Measures the effect of income change on demand.
  • Formula: Percentage change in quantity demanded รท percentage change in income.
  • Types:
    • Positive elasticity: Income and demand both rise (normal goods).

      • 1: Luxury goods.

      • <1: Necessities.
      • =1: Unitary, normal goods.
    • Negative elasticity: Income rises, demand falls (inferior goods).
    • Zero elasticity: Change in income does not affect demand (essential goods).

Cross Elasticity of Demand

  • Measures change in demand for one good when the price of a related good changes.
  • Formula: Percentage change in quantity demanded of good X รท percentage change in price of good Y.
  • Types:
    • Positive cross elasticity: Substitute goods.
    • Negative cross elasticity: Complementary goods.
    • Zero cross elasticity: Unrelated goods.

Key Terms & Definitions

  • Price Elasticity of Demand (ED/EP) โ€” Responsiveness of quantity demanded to a change in price.
  • Expenditure/Outlay Method โ€” Method using total expenditure to determine elasticity.
  • Point/Geometric Method โ€” Calculates elasticity at a single point on the demand curve.
  • Income Elasticity โ€” Change in demand due to income changes.
  • Cross Elasticity โ€” Change in demand for one good due to price changes in another related good.
  • Substitute Goods โ€” Goods that can replace each other.
  • Complementary Goods โ€” Goods used together.

Action Items / Next Steps

  • Review and practice problems on measuring elasticity using different methods.
  • Download lecture notes from the specified application.
  • Prepare a case study-based answer on factors affecting price elasticity for exams.

Full transcript