concept of elasticty and its application (+ handwritten notes too ).ppt

8/14/2019 Concept of elasticty and its application (+ handwritten notes too ).ppt

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Elasticity and Its

Application


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Elasticity . . .

is a measure of how much buyers and sellers respond

to changes in market conditions

allows us to analyze supply and demand with greaterprecision.

Elasticity of demand measures the responsiveness of

the quantity demanded of a good to change in its price,

price of other goods and changes in consumers income.


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Elasticity is of three types

Price elasticity of demandElasticity of

demand with respect to change in its

price

Income elasticity of demandElasticity

of demand with respect to change in

consumers income Cross elasticity of demandElasticity of

demand with respect to change in its

price of substitutes


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Price Elasticity of Demand

Price elasticity of demandis the

percentage (rate) change in quantity

demanded given a percent change in theprice.

is a measure of how much the quantity

demanded of a good responds to a changein the price of that good.


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Computing the Price Elasticity

of DemandThe price elasticity of demand is computed

as the percentage change in the quantity

demanded divided by the percentagechange in price.

Price Elasticity = Percentage Change in Qd

Of Demand Percentage Change in Price


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Ranges of Elasticity

I nelastic DemandPercentage change in price is greater than

percentage change in quantity demand.

Price elasticity of demand is less thanone.

Elastic DemandPercentage change in quantity demand is

greater than percentage change in price.Price elasticity of demand is greater thanone.


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Two extreme situations in

price elasticity of demand1. Zero Price elasticityIn response to change in price ,no

change in quantity demanded of a commodity. This

implies no extension or contraction of demand . It is

called perfectly inelastic demand. (PERFERCTLY

INELASTIC DEMAND)

E g. Water -- it's essential for survival

Bread -- same as above

Prescription drugs needed to save someone's life --

most people will pay any amount to save their life


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Perfectly Inelastic Demand

- Elasticity equals 0

Quantity

Price

4

$5

Demand

1002. ...leaves the quantity demanded unchanged.

1. Anincreasein price...


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Two extreme situations in

price elasticity of demand2. Infinite Price elasticityWhen a very small

change in price causes infinite change in quantity

demanded of a commodity.PERFECTLY ELASTIC DEMAND

E =

The horizontal line states that any quantity can be purchased

at OQ but even at a slightest increase in price beyond OQ

means no purchase at all

Pink marker pens. If pink marker pens were more

expensive than any other color, the demand would drop

to zero.


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Perfectly Elastic Demand

- Elasticity equals infinity

Quantity

Price

Demand$4

1. At any priceabove $4, quantity

demanded is zero.

2. At exactly $4,

consumers willbuy any quantity.

3. At a price below $4,quantity demanded is infinite.


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Normal Situations of Price

Elasticity of Demand1. Elasticity of demand = 1

2. Elasticity of demand > 1

3. Elasticity of demand


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Elasticity of demand = 1

Unitary Elasticity of demand

Elasticity

of demand

equal to

utility

curve

y

x0 deman

d

PR

I

C

E

D

D

When the

proportionate

change indemand is equal

to proportionate

changes in price,

it is known asunitary elastic

demand


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Unit Elastic Demand

- Elasticity equals 1

Quantity

Price

4

$51. A 25%increasein price...

Demand

100752. ...leads to a 25% decrease in quantity.


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Relatively elastic demand

Relatively elastic

demand curve

P

R

I

C

E

demand0 x

y

D

D

When the

proportionatechange in demand

is more than the

proportionate

changes in price, itis known as

relatively elastic

demand.

Total expenditureof a commodity

increases in

response to

decrease in price


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Elastic Demand

- Elasticity is greater than 1

Quantity

Price

4


Demand



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Relatively inelastic demand

Relatively

inelastic

demand curve

XO

Y

deman

d

D

D

P

R

I

C

E

When the

proportionate

change in demand

is less than the

proportionate

changes in price, it

is known as

relatively inelastic

demandTotal expenditure

of a commodity

decreases in

response to its price


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Inelastic Demand

- Elasticity is less than 1

Quantity

Price

4


Demand



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Measurement Of Price

Elasticity Of DemandThere are main methods like1. Percentage method or proportionate

method2. Total revenue method

3. Geometric method or point method

4. Arc elasticity of demand


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Percentage or Proportionate

Method % change in demand is divided by %

change in price

Ed= - %QD of commodity X

% in price of commodity X

= - Change in QD/Initial demand

Change in price/Initial price

= - Q/Q * 100 = -Q/Q * P/P

P/P * 100


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of Demand

priceinchangePercentage

demandedquatityinchangePercentagedemandofelasticityPrice

Example: If the price of an ice cream cone increasesfrom $2.00 to $2.20 and the amount you buy falls from

10 to 8 cones then your elasticity of demand would be

calculated as:

2percent10

percent20

100

002

002202

10010

810

.

)..(

)(


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Point Elasticity Method

Elasticity computed at a single point on the

curve for an infinitely small change in priceis called point elasticity


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Arc Elasticity of demand

It measures average responsiveness of

demand curve

Price elasticity of demand = Q . (P1 +P2)/2

P (Q1+Q2)/2

)/2]P)/[(PP(P

)/2]Q)/[(QQ(Q=DemandofElasticityPrice

1212

1212


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Revenue Method

The elasticity of demand can be

measured on the basis of change in total

expenditure in response to a change inprice.

Ed = AR

AR- MR


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of Demand

Example: If the price of an ice cream cone increasesfrom $2.00 to $2.20 and the amount you buy falls from

10 to 8 cones the your elasticity of demand, using the

midpoint formula,would be calculated as:

32.25.9

22

2/)20.200.2(

)00.220.2(

2/)810()810(

percent

percent

)/2]P)/[(PP(P

)/2]Q)/[(QQ(Q=DemandofElasticityPrice

1212

1212


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Determinants of


1. Nature of commodity

NecessariesSalt ,water 1

2. Availabi l i ty of substi tutes

3. Goods with dif ferent use4. Postponement of demand

5. Income of the consumer

6. Habit of consumer

7. Proportion of income spent on commodity


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Determinants of Price

Elasticity of Demand Demand tends to be more inelastic

If the good is a necessity.

If the time period is shorter.

The smaller the number of close substitutes.


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Determinants of


Demand tends to be more elastic :

if the good is a luxury.the longer the time period.

the larger the number of close

substitutes.


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Income Elasticity of Demand

Income elasticity of demandmeasures

how much the quantity demanded of a

good responds to a change in consumersincome.

It is computed as the percentage change

in the quantity demanded divided by thepercentage change in income.


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Computing Income Elasticity

Income Elasticity

of Demand

Percentage Changein Quantity Demanded

Percentage Changein Income

=


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Income Elasticity

- Types of Goods - Normal Goods

Income Elasticity is positive.

I nfer ior Goods

Income Elasticity is negative.

Higher incomeraisesthe quantity demandedfornormal goodsbut lowers the quantity

demanded forinferior goods.


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Cross Price Elasticity of

Demand Elasticity measure that looks at the

impact a change in the price of one good

has on the demand of another good. % change in demand of Q1

% change in price of Q2.

Positive for Substitutes

Negative for Complements.


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Importance of Price

Elasticity Determination of price under monopolyIf demand is elastic

will fix less price of good and vice versa

Taxation policyElastic demandless revenue, ineleastic demand

more revenue Distribution of burden of taxesInelastic goodsconsumers ,

elastic goods - producers

International tradecountry will gain if increase in exports and

demand of importing country is inelastic


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Elasticity of supply


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Elasticity of Supply-

The percentage change in quantity

supplied in response to percent change inprice


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MEANING OF ELASTICITY OF

SUPPLY :- IT IS DEFINED AS THE RESPONSIVENESS OF

THE QUANTITY SUPPLIED OF A GOOD TO A

CHANGE IN ITS PRICE.

ELASTICITY OF SUPPLY =

% CHANGE IN QUANTITY SUPPLIE D

------------------------------------------------

% CHANGE IN PRICE


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TYPES OF SUPPLY

ELASTICITY:- PERFECT INELASTIC SUPPLY :- I f as a

result of a change in pr ice, the quanti ty suppl ied

of a good remains unchanged, we say that theelasticity of supply is zero.

RELATI VELY LESS-ELASTIC SUPPLY :-I f as

a result of a change in the price of a good its

supply changes less than proportionately, we say

that elasticity of supply is less than one.


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Continue-

RELATIVELY GREATER ELASTIC

SUPPLY :- I f elastici ty of supply is greater than

one

when the quanti ty supplied of a good ischanges substantially in response to small

change in price of the good.

UNIT ELASTIC SUPPLY :- I f the relative

change in the quanti ty supplied is exactly equal

to the relative change in price, the supply is said

to be unitary elastic.


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PERFECT ELASTIC SUPPLY :- the

supply elastici ty is inf inite when nothing is

supplied at a lower price but a smallincrease in price causes supply to rise from

zero to an indefinitely large amount

indicating that producers wil l supply anyquanti ty demanded at that price.


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Importance of elasticity of

supply Taxation and elasticity of supply

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