elasticity
DESCRIPTION
ELASTICITY. RESPONSIVENESS. Price Elasticity of Demand. measures the responsiveness of the quantity demanded of a good or service to a change in its price. Price Elasticity of demand is calculated by dividing the percentage change in quantity by the percentage change in price. Ep =. - PowerPoint PPT PresentationTRANSCRIPT
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ELASTICITYELASTICITY
RESPONSIVENESSRESPONSIVENESS
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measures the responsivenessof the quantity demanded of
a good or service to a change in its price.
Price Elasticityof Demand
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Price Elasticity of demand is calculated by dividing the percentage change in quantity by the percentage change in price.
% QD
% PEp =
Use this method if both the price and the quantity data is given as percentages
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Mid - point methodMid - point method
Ep = Ep = ∆Q∆Q x ( x (p1 + p2)/2p1 + p2)/2
∆ ∆P (q1 + q2)/2 P (q1 + q2)/2
Use this method if we have two set of points
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What does the co-efficient What does the co-efficient mean?mean?
Co-efficientCo-efficient Type of Type of elasticityelasticity
0 - 10 - 1 InelasticInelastic
11 UnitaryUnitary
> 1> 1 ElasticElastic
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TOTAL REVENUE METHODTOTAL REVENUE METHODTOTAL REVENUE METHODTOTAL REVENUE METHOD
• IF PRICE AND IF PRICE AND TOTAL REVENUE TOTAL REVENUE MOVE IN THE MOVE IN THE SAME DIRECTION SAME DIRECTION THENTHEN
• IF PRICE AND IF PRICE AND TOTAL REVENUE TOTAL REVENUE MOVE IN MOVE IN OPPOSITE OPPOSITE DIRECTIONS THENDIRECTIONS THEN
INELASTICDEMAND ELASTIC
DEMAND
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P
$
4
2
0 6 7 Q
D
Ep = 1 * 3
2 6.5
= 0.23
= inelastic
EXAMPLE ONEEXAMPLE ONE
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Total revenue methodTotal revenue method
P
$
4
2
0 6 7 Q
DAn increase in price ($2-$4) causes an increase in total revenue ($14-$24).
A decrease in price ($4-$2) causes a decrease in total revenue ($24-$14)
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D
P
$
4
2
0 2 4 Q
Ep = 2 * 3
2 3
= 1
= unitary
EXAMPLE TWOEXAMPLE TWO
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Total revenue methodTotal revenue method
D
P
$
4
2
0 2 4 Q
An increase or decrease in price will have no affect on total revenue.
$4 x 2 = $8 $2 x 4 = $8
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P
$
4
3
0 4 6
D
Ep = 2 * 3.5
1 5
= 1.4
= elastic
EXAMPLE THREEEXAMPLE THREE
Q
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Total revenue methodTotal revenue method
An increase in price brings about a An increase in price brings about a decrease in total revenue (P*Q).decrease in total revenue (P*Q).($18 - $16)($18 - $16)
A decrease in price brings about an A decrease in price brings about an increase in TR increase in TR
(from $16 - $18)(from $16 - $18)
P
$
4
3
0 4 6
D
Q
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SPECIAL CASESSPECIAL CASESSPECIAL CASESSPECIAL CASES
P P
D
D
PERFECTLY INELASTIC.
A change in price brings about no response - no change in quantity demand.
PERFECTLY ELASTIC
A change in price brings about an infinite response in quantity demand.
Ed=0
Ed=
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Elasticities, Elasticities, Price Price Changes and Changes and Total Total RevenueRevenue
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What What determines determines elasticity for a elasticity for a product?product?
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1. Whether or not it has close substitutes.
No close substitutes = inelastic
Close substitutes = elastic
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2. Is it a necessity or a luxury?
Necessity = inelastic
Luxury = elastic
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3.Is it a small or large proportion of income?
Small proportion = inelastic
Large proportion - elastic
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4. Is it durable or not
Durable = more elastic. Consumption can be postponed until price falls
Non - durable = more inelastic. It is used up quickly so consumption can not be postponed.
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5. Is it addictive?
Addictive goods will have inelastic demand as some consumers can not do without them.
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Elasticity along the Demand Elasticity along the Demand CurveCurve
D
$
Q25
50
20
80
10 40
Point of Unitary Elasticity
Elastic Region
Inelastic Region
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Income elasticity of demand
measures the responsiveness
of the quantity demanded of a good or service to a
change in income.
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Income Elasticity of demand is calculated by dividing the percentage change in quantity by the percentage change in income.
% QD
% YEy =
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What does the co- efficient mean?
Co-efficientCo-efficient MeaningMeaning
NegativeNegative Inferior goodsInferior goods
0- 10- 1 Normal good - Normal good - necessitynecessity
> 1> 1 Normal good - Normal good - luxuryluxury
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Inferior Goods
Have a negative income elasticity because when income increases, less of the good will be purchased.
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Necessities
Have a income elasticity of between 0 and 1. This is an inelastic response, the percentage increase in amount purchased is less than the percentage increase in income.
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Luxuries
Have an income elasticity of greater than 1. This is an elastic response as the percentage change in amount purchased is greater than the percentage change in income.
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Cross-price elasticity of demand.
measures the responsivenessof the quantity demanded of
one good to changes in price of another good.
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Cross-price elasticity of demand is calculated by dividing the percentage change in quantity of one good by the
percentage change in price of the other good.
% Qx
% PyEcross =
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Complements.
These are goods that are used together. They will have a negative cross
elasticity.
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Substitutes
These are goods that are used in place of each other.
They will have a positive cross elasticity.