chapter5-supply and demand in individual market

8/2/2019 Chapter5-Supply and Demand in Individual Market

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SUPPLY & DEMAND ININDIVIDUAL MARKETS

By:Dr. Nazir Saeed

Secretary Information TechnologyGovernment of the Punjab


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Elasticity of Demand and

Supply


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Elasticity of Demand and Supply

Price Elasticity of Demand The law of download-sloping demand tell us

that quantity demanded tends to varyinversely with price.

Want to know how much quantity demandedwill change in response to a change in price?

The price elasticity of demand (sometimessimply called price elasticity) measures how

much the quantity demanded of a goodchanges when its price changes.


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Elasticity of Demand and Supplycontd.

Elasticity denotes responsiveness. The priceelasticity of demand is the responsiveness ofthe quantity demanded of a good to changesin the goods price, other things held constant.

The precise definition of price elasticity, ED, isthe percentage change in quantity demandeddivided by the percentage change in price, i.e.

ED = percentage change in quantity demandedpercentage change in price


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Elastic and Inelastic Demand

A good is elastic when its quantitydemanded responds greatly to price changesand is inelastic when its quantity demanded

responds little to price changes.

When 1% change in price call forth more than 1%change in quantity demanded, this is price-elasticdemand.

When 1% change in price evokes less than 1%

change in quantity demanded, this is price-inelastic demand.


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Elastic and Inelastic Demandcontd.

Three important points about elasticitymeasurements: -

Prices and demand moves in opposite directions

because of the law of downward-sloping demand.

For convenience percentage changes are treatedas positive number.

The use of percentage changes rather than actual

changes gives a nice property that the elasticity

measure is a pure number.

Slight ambiguity in measuring percentage

changes. The formula for a percentage change is

P/P.


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Price was 90 and quantity demanded was 240 units.A price increase led to 110 led consumers to reducetheir purchases to 160 units.

The price elasticity of demand is evidently ED =40/20=2


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To avoid ambiguity, always take the averageprice to be the base price for calculating pricechanges. The exact formula for calculatingelasticity is therefore: -

ED = Q P

(Q1 +Q2) (P1 + P2)

Where P1 and Q1 represent the original price

and quantity and P2 and Q2 stand for the newprice and quantity.


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Price elasticity varies from zero to infinityalong a straight line demand curve.

At mid-point of the demand curve is unit-elastic demand, which occurs whenpercentage change in quantity is exactly thesame size as the percentage change in price.


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Price Elasticity in Diagrams

Price is cut in half and consumers change theirquantity demanded from A to B.

Halving of price has tripled quantity demanded. Thiscase shows price-elastic demand.


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Price Elasticity in Diagramscontd.

Cutting price in half led to only 50% increasein quantity demanded. This case shows price-inelastic.

P i El i i i Di


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Doubling of quantity demanded exactlymatches the halving of price. Borderline caseof unit-elastic demand.

P i El i i i Di


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Perfectly inelastic demands are ones where quantity

demanded responds not at all to price changes. When quantity demanded is infinitely elastic, thisimplies that a tiny change in price will leads toindefinitely large change in quantity demanded,shown above.


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Slopes Vs. Elasticities

A steep slope for the demand curve meansinelastic demand and a flat slope signifieselastic demand?Wrong interpretation!


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Slopes Vs. Elasticities contd.

This straight-line demand curve has the sameslop everywhere but the top of line near A hasa very small percentage price change and avery large percentage quantity change, i.e.

elasticity is extremely high. When price is very low, price elasticity is verylow.

Above the mid-point M of any straight line,

demand is elastic with ED > 1. At the mid-point, demand is unit-elastic, with ED =1.Below the mid-point, demand is inelastic, withED < 1.


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Elasticity and Revenue

An increase in supply would tend to depressprice. Gregory King observed a less obviouspoint: Farmers as a whole receive less totalrevenue when the harvest is good than when

its bad. Paradoxically, good weather is badfor farmers incomes.

The reason is that a low price elasticity of

food means that a large harvests (high Q)tend to be associated with low revenue (low Px Q)


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Elasticity and Revenue contd.

Three cases of elasticity correspond to threedifferent relationships between total revenueand price changes: -When demand is price inelastic, a price decrease

reduces total revenue.

When demand is price elastic, a price decreaseincreases total revenue.

In the borderline case of unit-elastic demand, aprice decrease leads to no change in total

revenue. Total revenue at any point on a demand curve

can be found by examining the area of therectangle formed by the P and Q at that point.


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shaded revenue region (P x Q) is $1000 million for

both points A and B. Unit-Elastic Demand.


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The revenue expands from $1000 million to $1500million when the price is halved. Demand is elastic.


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The revenue rectangle falls from $40 millionto $30 million when price is halved. Inelastic

Demand.


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Value ofdemandelasticity

Description Definition Impact onrevenue

Greater than one

(ED > 1)

Elastic demand % change in quantity

demanded greaterthan % change inprice

Revenues increases

when price decreases

Equal to one (ED =

1)

Unit-elastic

demand

% change in quantity

demanded equal to %

change in price

Revenues unchanged

when price decreases

Less than one (ED

chapter5-supply and demand in individual market

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