ifim elasticity

8/8/2019 IFIM Elasticity

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The price el ast icity of dem an d an d its de termi nants

Dem an d tends to be more el ast ic (inelast ic):

th e la rger (Fewer ) th e number of clo se sub st itutes if th e good i s a luxur y (nece ss ity) th e more na rrowl y(bro ad) defi ned th e m arke t th e long er ( sh or ter ) th e t ime period


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Compu t ing th e price el ast icity of dem an d

The price el ast icity of dem an d is compu ted as th eperce ntag e chang e in th e qu ant ity dem an deddivided b y th e perce ntag e c hang e in price.

E d =% change in quantity demanded

% change in price


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Compu t ing th e price el ast icity of dem an d(poi nt elast icity)

Example : If th e price of an ice cre am co neincre as es from $2.00 to $2.20 an d th e amou nt you bu y f a lls from 10 to 8 co nes, th en your

elast icity of dem an d would be c a lculat ed as (ignoring the negative sign ):

( )

( . . ).

.

10 88 100

220 200220

100

25%9%

27v

v

! !

75.2

275.010820.2

20.02

!

v!

v!

v(

(

Q P

P Q


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The Arc el ast icity me th od

The arc elasticity formula is prefer ablewhen ca lculat ing th e price el ast icity of dem an d bec ause it gives th e sa means wer re ga rdle ss of th e direc t ion of th echang e.

P rice elasticity of demand =

v

((

Q p

P Q


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Ca lculat e u sing th e arc elast icity me th od

Example : If th e price of an ice cre am co neincre as es from $2.00 to $2.20 an d th eamou nt you bu y f a lls from 10 to 8 co nes, th en your el ast icity of dem an d , using th e arcelast icity formul a, would be c a lculat ed as (ignoring the negative sign ):

3.22

3.010

1820.4

20.02

!

v

!v

7

7v(

(

Q P

P Q


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Inelastic demand Q uant ity dem an ded doe s not re spo nd

st rong ly to price c hang es. Price el ast icity of dem an d is less than one.

E lastic demand Q uant ity dem an ded re spo nds st rong ly to

chang es in price. Price el ast icity of dem an d is great er than

one.

Inelastic demand Q uant ity dem an ded doe s not re spo nd

st rong ly to price c hang es. Price el ast icity of dem an d is less than one.

E lastic demand Q uant ity dem an ded re spo nds st rong ly to

chang es in price. Price el ast icity of dem an d is great er than

one.

The variety of demand curves


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The varie ty of dem an d curve sPerfectly inelastic Q uant ity dem an ded doe s not re spo nd to

price c hang es.

Perfectly elastic Q uant ity dem an ded c hang es infin itely with

any chang e in price.

nit elastic Q uant ity dem an ded c hang es by th e sa meperce ntag e as th e price.

Perfectly inelastic Q uant ity dem an ded doe s not re spo nd to

price c hang es.

Perfectly elastic Q uant ity dem an ded c hang es infin itely with

any chang e in price.

nit elastic Q uant ity dem an ded c hang es by th e sa meperce ntag e as th e price.


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Because th e price el ast icity of dem an dme as ure s how muc h qu ant ity dem an dedre spo nds to th e price , it is closely relat ed to

th e slope of th e dem an d curve.

The variety of demand curves


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(b) Inelastic demand: elasticity is less than 1

Quantity0

$5

90

Deman d1 . A 22%incre as ein price ...

Price

2. ... le ads to an 11 % decre as e in qu ant ity dem an ded.

4

100

The price el ast icity

of dem an d


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of dem an d

Cop yright2003 S o uthwestern/Th o ms o n Learning

2. ... le ads to a 22% decre as e in qu ant ity dem an ded.

(c) Unit elastic demand: elasticity equals 1

Quantity

4

1000

Price

$5

80

1 . A 22%incre as ein price ...

Deman d


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of dem an d(d) Elastic demand: elasticity is greater than 1

Deman d

Quantity

4

1000

Price

$5

50

1 . A 22%incre as ein price ...

2. ... le ads to a 67% decre as e in qu ant ity dem an ded.


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of dem an d(e) Perfectly elastic demand: elasticity equals infinity

Quantity0

Price

$4 Deman d

2. At exact ly $4 ,cons umer s willbu y any qu ant ity.

1 . At any priceabove $4 , qu ant ity

dem an ded i s zero.

3. At a price below $4 ,qu ant ity dem an ded i s in fin ite.


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(a) Perfectly inelastic demand: elasticity equals 0

$5

4

Quantity

Deman d

1000

1 . Anincre as ein price ...

2. ... le aves th e qu ant ity dem an ded u nchang ed.

Price


of dem an d


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Tota l reve nue an d th e priceelast icity of dem an d

T otal revenue is th e amou nt pa id by bu yer s an d received b y seller s of a good.

Ca lculat ed as th e price of th e good t ime s th e qu ant ity sold.

TR= P x Q


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Tota l reve nue


Deman d

Quantity

Q

P

0

Price

P Q = $400

(reve nue )

$4

100


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How tota l reve nue c hang es: inelast icdem an d


Dem an d

Quantity0

Price

Reve nue = $100

Quantity0

Price

Revenue = $240

Dem an d$1

100

$3

80

An Increase in p rice fr o m $1to $3

leads t o an Increase in t o talrevenue fr o m $100 t o $240

With an inelast ic dem an d curve , an incre as e in price le ads to a decre as e in

qu ant ity that is propor t ionat ely sma ller. Thus, tota l reve nue incre as es.


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How tota l reve nue c hang es: elast icdem an d


Dem an d

Quantity0

Price

Revenue = $200

$4

50

Dem an d

Quantity0

Price

PXQ =$5x 20Revenue = $100

$5

20

An Increase in p rice fr o m $4to $5

leads t o an decrease in t o talrevenue fr o m $200 t o $100

With an elast ic dem an d curve , an incre as e in th e price le ads to a decre as e in qu ant ity dem an ded that is propor t ionat ely larger. T hus, tota l reve nue decre as es.


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Income el ast icity of dem an d

Income elasticity of demand me as ure s howmuc h th e qu ant ity dem an ded of a goodre spo nds to a chang e in cons umer s income.It is ca lculat ed as th e perce ntag e chang e in th e qu ant ity dem an ded divided b y th eperce ntag e chang e in income.

% change in inc o me

Inco me elasticity o f Demand =

% change in quantity demanded


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Income el ast icity

Type s of good s N ormal good s ha ve po sit ive income

elast icity Inferior good s ha ve negat ive income

elast icity

H igh er income r a ises th e qu ant ity

dem an ded for norm a l good s bu t lower s th e qu ant ity dem an ded for i nferiorgood s.


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Income el ast icity

Good s cons umer s re ga rd as nece ss it ies tend to be i ncome i nelast ic.

Example s include food , fuel , cloth ing, ut ilit ies an d medic a l service s.

Good s cons umer s re ga rd as luxurie s tendto be i ncome el ast ic.

Example s include spor ts cars, furs, an dexpe ns ive food s.


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What is cross -elast icity of dem an d?

The rat io of th e perce ntag e c hang e in qu ant ity dem an ded of a good to a given perce ntag e c hang e in price of an oth er good :Cross elast icity ca lculat ions reve a l whe th er good s a resubstitutes or co mp lements in use.

Wh en your ans wer i s po sitive it me ans that a rise in th e price of let s say pe n will lead to an incre as e in th e qu ant ity dem an dedof pe ncil substitutes .Wh en your ans wer i s negative it me ans that a rise in th e price of let s say cars will lead to a decre as e in th e qu ant ity dem an ded of pe trol co mp lements.

% change in quantity demanded of good A% change in price of good B

Ed =


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The el ast icity of suppl y

Price elasticity of su pp ly is a me as ure of howmuc h th e qu ant ity supplied of a goodre spo nds to a chang e in th e price of that good.

E p of Suppl y = % change in quantity supplied% change in price

If E >1 th en th is reflec ts that th e qu ant ity supplied move s propor t ionat ely more than its price , suppl y is sa id to be El ast ic


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Determi nants of el ast icity of suppl y

Ability of seller s to chang e th e amou nt of th e good th ey produce.

Beach-front lan d is inelast ic. Ep < 1In th e above c as e p rice elasticity o f supp ly will

be less than 1 where the quantity su pp liedmo ves p ropo rti o nately less than the p rice.

Books, cars, or m an uf actured good s are el ast ic.

Time period. Supply is more el ast ic in th e long run .


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Elast icity an d tax incide nce

T ax incidence is th e m ann er in wh ich th eburde n of a tax is sha red amo ng pa rt icipants in a ma rke t .Tax incide nce is th e st ud y of who be a rs th e burde n of a tax .Taxes re sult in a chang e in ma rke t

equilibrium.Buyer s pay more an d seller s receive le ss, re ga rdle ss of whom th e tax is levied o n .


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What is th e imp act of tax ? Taxes discour ag e m a rke t act ivity. Wh en a good i s tax ed , th e qu ant ity sold is

sma ller. Buyer s an d seller s sha re th e tax burde n .


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A tax on bu yer s


Quantity o f ice-cream c o nes

0

Price o f ice-creamco ne

Price

with ou ttax

Priceseller sreceive

Equilibrium wi th ou t taxTax ($0.50 )

Pricebu yers

pay

D1

D2

Suppl y, S1

A tax on bu yerssh if ts th e dem an dcurve dow nwardby th e size of th e tax ($0.50 ).

$3.30

90

Equilibriumwith tax

2.80

3.00

100


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A tax on seller s


2.80

Quantity o f ice-cream c o nes

0

Price o f ice-cream

co ne

Price

with ou ttax

Priceseller sreceive

Equilibriumwith tax

Equilibrium wi th ou t tax

Tax ($0.50 )

Pricebu yer s

payS1

S2

Deman d, D1

A tax on seller ssh if ts th e suppl ycurve upw ardby th e amou nt of th e tax ($0.50 ).

3.00

100

$3.30

90


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In what propor t ions is th e burde n of th etax divided?H

ow do th e effec ts of tax es on seller s comp are to th ose levied o n bu yer s?The ans wer s to th ese que st ions depe ndon th e el ast icity of dem an d an d th eelast icity of suppl y.


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How th e burde n of a tax is divided


Quantity0

Price

Deman d

Supply

Tax

Price seller sreceive

Price bu yer s pay

(a) Elastic su pp ly, inelastic demand

2. ... th eincide nce of th etax f a lls moreheavily oncons umer s ...

1. Wh en suppl y is more el ast icthan dem an d ...

Price wi th ou t tax

3. ... than on producer s.


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How th e burde n of a tax is divided


Quantity0

Price

Dem an d

Supply

Tax

Price seller sreceive

Price bu yer s pay

(b) Inelastic su pp ly, elastic demand

3. ... than oncons umer s.

1. Wh en dem an d is more el ast icthan suppl y ...

Price wi th ou t tax

2. ... th eincide nce of th e tax f a lls more heavily on producer s ...


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Review que st ion

E conomists have observed that s pendingon restaurants meals declines moreduring economic recession than doess pending on food to be eaten at home .

How mi ght th e co ncep t of el ast icity helpto e xpla in th is phenome non?

AUT Faculty of Business & Law 20 10 38

ifim elasticity

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