eom3 elasticity of demand by kuldeep ghanghas

8/8/2019 EoM3 Elasticity of Demand by kuldeep ghanghas

1/18

S&N, Ch. 4Mw, Ch. 5

Sr, pp. 85-95


2/18

` When price rises, what happensto demand?

` Demand falls

` BUT!` How much does demand fall

` Elasticity measures the extent to which

demand will change


3/18

Types of Elasticity

Priceelasticity

of demand

Priceelasticity

ofsupply

Incomeelasticity

of demand

Cross

elasticity


4/18

Price elasticity of demand (EDP ) measures how much the quantitydemanded responds to a change in price

EDP is normally negative, but we can ignore the negative sign

EDP =

Percentage change in quantity

demandedPercentage change in price


5/18

` At P1= $90, Q1 =240 units are demanded

` At P2 = $110, Q2 =160 units are demanded

` % change in quantity is (Q/Qave) 100%

` Q = Q2 - Q1 =160 240 = - 80` Qave = (Q1 + Q2) / 2= (240 +160 ) / 2=200

` % change in Q = (-80 / 200) 100% = - 40%


6/18

` % change in price is (P/Pave) 100%

` P=P2 - P1 =110 90 =20

` Pave = (P1 +P2) / 2= (90 +110 ) / 2=100

` % change in price is (20/100) 100% =20%` EDP = - 40 / 20 = - 2

` (We can ignore the minus sign)


7/18

When EDP is greater than 1,demand is elastic(flatter demand

curve)

Relative change in demand islarger than the relative change in theprice

With elastic demand raising prices

lowers total revenue (revenue =P Q)

P

Q

D

D

Q

P

D

D

When EDP is lesser than 1,demand is inelastic(steeper

demand curve)

Relative change in demand islesser than the relative change in theprice

With inelastic demand raising

prices increases total revenue(revenue =P Q)


8/18

P

Q

P

Q

D

D P

Q

D

EDP= 0 is perfectly

inelastic demand (avertical demandcurve demanddoes not change withprice)

EDP=1 is unit elastic

demand (raisingprices does not

change revenues)

EDP= is perfectly

elastic demand (ahorizontal demand

curve )

D

D

D


9/18

ncomeel ticit of emand ( I )measures owmuch the uantit demandedresponds toachange inconsumers income.

I ispositive fornormal good

EDI isnegative for inferiorgood

EDI =

Percentagechange in uantitdemanded

Percentagechange in income


10/18

Normalgoods havepositive EDI,

e.g. as income

rises people gofor morevacations

Inferiorgoods have

negativeEDI,

e.g. as incomesrise people

switch frombuses to usingautos and taxis,

or buy cars

Necessitiesusually have

small EDI,

like food

Luxuriesusually have

large EDI,

like jewelry andcars


11/18

Cross-price elasticity of demand (EDC) measures how much the quantitydemanded in one good responds to a change in the price of another good

EDC can have either sign

EDC =

Percentage change in quantitydemanded of good 1

Percentage change in price of good 2


12/18

If the two goodsare substitutes

EDC is positive

E.g. hot dogs andhamburgers are

substitutes. If theprice of hot dogs goesup, people buy

hamburgers instead

If two goods arecomplements

EDC is negative

E.g. If the price oftrousers goes uppeople buy fewer

trousers and fewerbelts


13/18

rice, potatoes and pasta tape players, CD players, MP3 players ballpoint pens, fountain pens, felt-tip

pens

Substitutes aregoods that canreplace others

With substitutes an increase in the price of one leads toan increase in the demand for the other

Where substitutes exist demand will be more elastic-Ifthe price of potatoes rises and the price of pasta doesnot, people switch from eating potatoes to eating pasta


14/18

trousersand elts computers, software internetconnections

ginand tonicwater

Complementsaregoods that

areused

together

With complementsan increase in thepriceofone leads toadecrease indemand for the

other


15/18

Time period

the longer thetime under

consideration themore elastic a

good is likely tobe

Number andcloseness ofsubstitutes

the greater thenumber of

substitutes, themore elastic

Theproportion ofincome taken

up by theproduct

the smaller theproportion themore inelastic

Luxury orNecessity

the more theluxurious, themore elastic


16/18

Price elasticity of supply (ESP) measures how much thequantity supplied responds to a change in price

If ESP is inelastic - it will be difficult for suppliers toreact swiftly to changes in price

If ESP is elastic supply can react quickly to changesin price

ESP =Percentage change in quantitysupplied

Percentage change in price


17/18

Relationship between changes in price and totalrevenue

Importance in determining what goods to tax(tax revenue)

Importance in analysing time lags in production

Influences the behaviour of a firm


18/18

` Theory of the consumer S&N, Ch 5,Appendix 5

Mw, pp.137-142

eom3 elasticity of demand by kuldeep ghanghas

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