lecture 3 elasticity. general concept elasticity means responsiveness. it shows how responsive one...
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Lecture 3Elasticity
General Concept
• Elasticity means responsiveness. It shows how responsive one variable is due to the change in another variable.
• In economics, elasticity is the measurement of how changing one economic variable affects others. For example:
• "If I lower the price of my product, how much more will I sell?“
• Or, "If I raise the price, how much less will I sell?”
General Formula
• Suppose, X is the independent variable and Y is the dependent variable. So when X changes it leads to a change in Y. Elasticity shows how responsive Y is to the change of X.
• How to calculate elasticity?• Elasticity is the percentage change in Y due to
1% percentage change in X. • Formula:• Elasticity =
ΔY/Y ΔX/X
Types of Elasticity
There are two broad type of elasticity1) Price Elasticity2) Income Elasticity Price elasticity can be classified as:a) Own price elasticityb) Cross price elasticity
Own Price Elasticity
a) Own Price Elasticity: Here we consider how a change in the price of a good affects the quantity ( demanded or supplied) of that good.
Definition: It is the percentage change of quantity due to the 1% change in its own price.
Formula:Own Price Elasticity=
ΔQ1/Q1 ΔP1/P1
Cross Price Elasticity b) Cross Price Elasticity: Here we consider how a change in the price of a
good affects the quantity ( demanded or supplied) of another good.Definition: It is the percentage change of quantity of a good due to the 1%
change in the price of another good. Formula:Cross Price Elasticity= Where, P1 is the price of good 1 and Q1 is the quantity of good 1P2 is the price of good2 and Q2 is the quantity of good 2
• If the two goods are substitute goods then the elasticity will be positive.• If the two goods are complementary goods then the elasticity will be
negative.
ΔQ2/Q2 ΔP1/P1
Income Elasticity
• It shows how a change in income of a consumer affects the quantity demanded of a good.
• Definition: It is the percentage change of quantity demanded of a good due to the 1% change in the income of a consumer.
Formula:Income Elasticity= Here m is income
ΔQ/Q Δm/m
Value and Sign of ElasticityPrice Elasticity of Demand: Own Price elasticity of demand is always
negative (sign). Why?- Because of negative relationship between price and quantity
demanded.- The range of value of price elasticity of demand is from 0 to negative
infinity. Price Elasticity of Supply: Own Price elasticity of supply is always
positive (Sign). Why?- Because of positive relationship between price and quantity supplied.
- The range of value of price elasticity of supply is from 0 to positive infinity.
• Elastic Demand: It means that 1% increase in price leads to a decrease in quantity demanded by more than 1%.
The value of elastic demand is between -1 and negative infinity.
• Inelastic Demand: It means that 1% increase in price leads to a decrease in quantity demanded by less than 1%.
The value of inelastic demand is in between 0 and -1.
• Unit Elastic Demand: It means that 1% increase in price leads to a decrease in quantity demanded by exactly 1%.
The value of inelastic demand is exactly -1.
• Elastic Supply: It means that 1% increase in price leads to an increase in quantity supplied by more than 1%.
The value of elastic supply is between 1 and positive infinity. • Inelastic Supply: It means that 1% increase in price leads to an increase in quantity
supplied by less than 1%.
The value of elastic supply is in between 0 and 1.
• Unit Elastic Supply: It means that 1% increase in price leads to an increase in quantity supplied by exactly 1%.
The value of unit elastic supply is exactly 1.
The Price Elasticity of Demand
(a) Perfectly Inelastic Demand: Elasticity Equals 0
$5
4
Quantity
Demand
1000
1. Anincreasein price . . .
2. . . . leaves the quantity demanded unchanged.
Price
The Price Elasticity of Demand
(b) Perfectly Elastic Demand: Elasticity Equals Infinity
Quantity0
Price
$4 Demand
2. At exactly $4,consumers willbuy any quantity.
1. At any priceabove $4, quantitydemanded is zero.
3. At a price below $4,quantity demanded is infinite.
Exercise
Period Price Toyota Quantity Demanded Toyota
1st 20 802nd 30 20
Find Elasticity and interpret (whether you have elastic, inelastic or unit elastic demand/ supply)
Own Price Elasticity of DemandExample: 1
Period Price Toyota Quantity Supplied Toyota
1st 10 20
2nd 20 60
Own Price Elasticity of SupplyExample: 2
Period Price of Honda Quantity Demanded Toyota
1st 20 202nd 40 80
Period Price of sugar Quantity Demanded Tea1st 10 202nd 30 10
Cross Price ElasticityExample: 3 and 4
Period Income Quantity Demanded Toyota
1st 100 302nd 200 90
Income Elasticity:Example: 5
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