4 lesson 03 - elasticity

8/11/2019 4 Lesson 03 - Elasticity

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After studying this chapter, you will be ableto: Define and calculate the price elasticity ofdemand Use a total revenue test and anexpenditure test to estimate the priceelasticity of demand Explain the factors that influence theprice elasticity of demand Define and calculate the cross elasticityof demand

Define and calculate the income elasticityof demand Define and calculate the elasticity ofsupply

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What is ELASTICITY?

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Elasticity is a measure of responsiveness ofone variable to another

Price and quantity demanded

Income and quantity demanded

Price and quantity supplied, etc


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Price Elasticity of Demand

Measures the sensitivity of quantity

demanded to price changes.

It measures the percentage change in thequantity demanded for a good or service that

results from a one percent change in the price.The price elasticity of demand is:

P)Q)/(%(%EP

Price elasticity of demand =Percentage change in quantity demanded

Percentage change in price

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Calculating Elasticities

Point Elasticity Approach:price

elasticity of

demand

Q = (QaQb)

P = (PaPb)

Pa

Qa

a

a a a

PQQ P

Q P P Q

The subscript

astands for after price change bstands forbefore price change

$

Q

Pb

Qb

Price

elasticity of

demand

Percentage change in quantity demanded (Q)

Percentage change in its own price (P)=

6

Single point

on curve

%in Q %in P

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Challenge 01

1. The Nugegoda Kentucky Fried Chicken (KFC)outlet typically sells 1,500 Chicken buckets per

month at $3.50 each

2. The price elasticity for the chicken bucket is

estimated to be0.30

3. If the KFC outlet increases the price of the bucket

to $4.00:

a. How many chi.buckets will the KFC outlet sellafter the price change?__________

b.The KFC outlets revenue will change by

$__________

c. Will consumers be worse or better off as a

result of this price change?_________7 7


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Calculating Elasticities

Percentage change in quantity

Percentage change in own price=

where:

P = (Pa+ Pb) 2Q= (Qa+ Qb) 2

Q = (QaQb)

P = (PaPb)

Arc Elasticity Approach:

Own pr iceelasticity of

demand

Q PQ P

Q P P Q

The subscript

astands for after price change bstands forbefore price change

Avg Price

Avg Quantity

Pa

Pb

Qa Qb

Specific range

on curve$

Q

P

Q

Priceelasticity of

demand

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Challenge 02

Calculate the Arc elasticity of demandfor the following combinations;

1. P0 = $89; Q0 = 1000; P1 = $99; Q1 = 9502. P0 = $89; Q0 = 1000; P1 = $99; Q1 = 700

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Elasticity Along a Demand Curve

Price

$1098

76543

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0 1 2 3 4 5 6 7 8 9 10 Quantity

Elasticity declines alongdemand curve as we move

toward the quantity axis

Ed= 1

Ed= 0

Ed< 1

Ed> 1

Ed=

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The Variety of Demand Curves

Inelastic Demand

Quantity demanded does not respond strongly to pricechanges.

Price elasticity of demand is less than one.

Elastic Demand

Quantity demanded responds strongly to changes inprice.

Price elasticity of demand is greater than one.

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Perfectly Inelastic (PE=0)

Quantity demanded does not respond to pricechanges.

Perfectly Elastic (PE= ) Quantity demanded changes infinitely with any change

in price.

Unit Elastic (PE=1)

Quantity demanded changes by the same percentageas the price.

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Inelastic demand Elastic demand Unity demand

Perfectly inelastic Perfectly elastic

P

Q

PP

PP

Q Q

Q Q 13


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Description Numerical

value

Total Outlay/Revenue

Infinitely elastic ED = Zero for a price rise, infinite for aprice fall

Elastic ED> 1 Decreases for a price rise, increases

for a price fallUnitary elastic ED=1 Remains the same whether price

rises or falls

Inelastic ED


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The primary determinant of priceelasticity of demand

The availability of substitutes

Many substitutes demand is price elastic

Few substitutes demand is price inelastic

Nature of commodity

Luxuries goods more elastic

Necessities goods less elastic

Proportion of income spent

Proportion is smallinelastic

Proportion is highmore elastic 15


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Income Elasticity of Demand Income elasticity of demandmeasures how much the

quantity demanded of a good responds to a change inconsumersincome.

It is computed as the percentage change in thequantity demanded divided by the percentage change

in income.

Income elasticity of demand =

Percentage changein quantity demanded

Percentage changein income

Y

Q

Q

Y

YY

QQEy x

x

xx

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When the income

elasticity is:The good is classified as:

Greater than 0.0 A normalgood

Greater than 1.0A luxury(anda normal)

good

Less than 1.0 butgreater than 0.0

A necessity(and anormal)good

Less than 0.0 An inferiorgood

Interpreting the Income

Elasticity of Demand

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Challenge 03

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The quantity demanded for tea increasesfrom 200kgs per week to 250kgs per week

due to an increase in income of the buyer

from Rs. 6000/- per week to Rs. 6500/- perweek.

Calculate the income elasticity of demand.


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Cross elasticity of demand

Cross elasticity of demandmeasures the percentage

change in the quantity demanded of one good thatresults from a one percent change in the price ofanother good.

For example consider the substitute goods, butter and

margarine.

m

b

b

m

mm

bbPQ

P

Q

Q

P

/PP

/QQE mb

The cross elasticity for substitutes is positive, whilethat for complements is negative.

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If the Cross-Price

Elasticity is:

The Good is

Classified as a:Positive Substitute

Negative Complement

Zero Independent

Interpreting the Cross

Price Elasticity ofDemand

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Challenge 04

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The quantity demanded for tea increasesfrom 200kgs per week to 250kgs per week

due to an increase in price of coffee from

Rs. 60/- per week to Rs. 65/- per week.Calculate the cross elasticity of demand.


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Price elasticity of supply

Price elasticity of supply measures the percentage

change in quantity supplied resulting from a 1 percentchange in price.

The elasticity is usually positive because price and

quantity supplied are directly related.

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The Variety of supply Curves

Inelastic Supply

Quantity supplied does not respond strongly to pricechanges.

Price elasticity of supply is less than one.

Elastic Supply

Quantity supplied responds strongly to changes inprice.

Price elasticity of Supply is greater than one.

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The Variety of Supply Curves

Perfectly Inelastic (PE=0)

Quantity supplied does not respond to price changes.

Perfectly Elastic (PE= )

Quantity supplied changes infinitely with any changein price.

Unit Elastic (PE=1)

Quantity supplied changes by the same percentage asthe price.

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The Variety of Supply Curves

Inelastic SupplyElastic Supply Unity Supply

Perfectly inelastic Perfectly elastic

P

Q

PP

PP

Q Q

Q Q 25


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Challenge 05

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The quantity supplied of tea increases from200kgs per week to 300kgs per week due

to an increase in price of tea from Rs. 60/-

per week to Rs. 70/- per week.Calculate the elasticity of supply.


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NOW YOU CAN;

Define and calculate the price elasticity of

demand Use a total revenue test and anexpenditure test to estimate the priceelasticity of demand

Explain the factors that influence theprice elasticity of demand Define and calculate the cross elasticityof demand

Define and calculate the income elasticityof demand Define and calculate the elasticity ofsupply

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4 lesson 03 - elasticity

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