elasticity of demand. scenariopricequantity demanded a92 b84 c5.59 d4.511 e216 f118 we start with a...

ELASTICITY OF DEMAND

Scenario Price Quantity demanded

A 9 2

B 8 4

C 5.5 9

D 4.5 11

E 2 16

F 1 18

We start with a hypothetical demand schedule

From the left-side Table we observe that from A to B, Change of price is -1, and change of quantity demanded is 2. Similarly from C to D, Change of price is -1, and change of quantity demanded is 2. and from E to F, Change of price is -1, and change of quantity demanded is 2.

So, our hypothetical demand curve will be linear similar to left one.

AB

CD

EF

Quantity demanded

P

Calculation of Elasticity

Elasticity between the point A and B =

There are two issues to calculate percentage change. Issues are (1) which one be Base price ? And (2) Which one be Base quantity ?

Scenario Price Quantity demanded

A 9 2

B 8 4

C 5.5 9

D 4.5 11

E 2 16

F 1 18

Calculation of Elasticity on a linear demand curve:-

A to B

In our calculation we didn’t address the issue (problem). Our Base price and quantity are initial price and quantity. In order to address the issue we can calculate elasticity taking average of initial value and next value.

Calculation of elasticity taking average of initial value and next value:-

Scenario Price Quantity demanded

A 9 2

B 8 4

C 5.5 9

D 4.5 11

E 2 16

F 1 18

Practice calculating elasticity between C and D; E and F points

AB

CD

EF

Elasticity is greater than 1

Elasticity is less than 1

Elasticity is equal to 1

Elasticity along a linear demand curve

An important point is when unit of change between two points are same but % change is different. Why ?

The answer is – because of initial value. the percentage change in price becomes smaller when the initial value is larger.

1) a price increase from $1 to $2 represents a 100% increase in price,

2) a price increase from $2 to $3 represents a 50% increase in price,3) a price increase from $3 to $4 represents a 33% increase in price, and4) a price increase from $10 to $11 represents a 10% increase in price.

Notice that, even though the price increases by $1 in each case, the percentage change in price becomes smaller when the initial value is larger.

Examples:-

PRICE ELASTICITY OF DEMAND Demand is said to be:

elastic when Ed > 1, unit elastic when Ed = 1, and inelastic when Ed < 1.

ELASTICITY IN DIAGRAM:-

(a) Elastic demand (b) Unit-elastic demand © Inelastic demand

Elasticity range from 0 to infinity

Q Q Q

P D P D P D

D D D

10% more than 10%

10% equal to10% 10% less than 10%

The price drops by 1 percent, causing the quantity demanded increase by 2 percent, so demand is therefore what ? Elastic or inelastic, is it greater than one, equal to one, or less than one. ? What would happen if quantity demanded increase by half percent instead of 2 percent ?

Quiz

What are the determinants of price elasticity of demand ?

Rice Coffee Tea

Shoe BMW car Salt

Is it essential for livelihood ?Major share of budget is spent for what ?Do the commodities have close substitution ?

What are the determinants of price elasticity of demand.

Essential goods like rice, salt have inelastic demand curve mean quantity demanded is less responsive to change of price of the goods. On the otherhand luxury goods has high responsive demand curve.

0 Quantity

High responsive demand curve i.e. elastic

Less responsive demand curve i.e. inelastic

DP

Quantity 0

Highly inelastic because very essential and no substitution.

These commodities are not essential for life; moreover, tea and coffee are close substitute for each other. So, their demand curve should be elastic

D

D

D

Scenario Price Quantity demanded

Total Revenue

A 9 2 18

B 8 4 32

C 5.5 9 49.5

D 4.5 11 49.5

E 2 16 32

F 1 18 18

2 4 9 11 16 180

10

20

30

40

50

60 Total Revenue

Quantity demanded

TR

Total Revenue and E

lasticity

TR = Price * Quantity

Ed < 1

2 4 9 11 16 180

10

20

30

40

50

60

0 1 2 3 4 5 6 7 8 9 100

2

4

6

8

10

12

14

16

18

20

Total Revenue and E

lasticity

TR up

TR down

Ed < 1

Ed > 1Ed = 1