Description
concept of elasticity, degree of elasticity, price elasticity, income elasticity of demand, cross elasticity, determinants of elasticity, importance of elasticity.
Elasticity of Demand
Elasticity: the Concept
?
?
? ? ? ?
?
The responsiveness of one variable to changes in another When price rises, what happens to demand? Quantity demanded falls BUT! How much does demand fall? “Elasticity” is a (standard) measure of the degree of sensitivity (or responsiveness) of one variable to changes in another variable. The elasticity measure is a ratio between two percentage measures: percentage change in one variable over the percentage change in another variable
Elasticity of Demand
Price elasticity of demand: The (self) price elasticity of demand is a measure of the degree of sensitivity of demand to changes in the (self) price, ceteris paribus. ? 2 situations: ? Where % change in quantity demanded is greater than % change in price – elastic ? Where % change in quantity demanded is less than % change in price - inelastic
?
Degrees
?
Perfectly elastic demand
?
?
?
ep=? (in absolute terms) Unlimited quantities can be sold at the prevailing price and even a negligible increase in price would result in zero quantity demanded Perfectly elastic demand curve is a horizontal line, parallel to the quantity axis ep>1 (in absolute terms), A proportionate change in quantity demanded is more than a proportionate change in price Flatter demand curve ep =1 (in absolute terms) Rectangular hyperbola, asymptotic to the axes Uncommon in real life
?
Highly elastic demand
? ? ?
?
Unitary elastic demand:
? ? ?
Degrees
?
Relatively inelastic demand:
? ep<1
(in absolute terms) ? Steeper demand curve ? Necessities, since they are less responsive to a given change in price
?
Perfectly inelastic demand:
? ep=0
(in absolute terms) ? Quantity demanded is totally unresponsive changes in price. ? Neutral goods ? Vertical demand curve, parallel to the price axis
to
Elasticity (more)
% Change in Quantity Demanded ___________________________ % Change in Price
Ped =
If value is between 0 and -1: the relationship is inelastic If value is between -1 and infinity: the relationship is elastic Note: PED has – sign in front of it; because as price rises demand falls and vice-versa (inverse relationship between price and demand)
Size of Price Elasticities
Unit elastic Inelastic
0 1 2 3 4 5
Elastic
6
? ? ?
Unit elastic: price elasticity equal to 1 Inelastic: price elasticity less than 1 Elastic: price elasticity greater than 1
General Formula for Price Elasticity
?
? ? ?
P = Current price of a good Q = Quantity demanded at that price DP = Small change in the current price DQ = Resulting change in quantity demanded
PercentageChange in Quantity Demanded Elasticity ? PercentageChange in Price
DQ Elasticity ? Q
d ln Q ? DP d ln P P
Slope of the Demand Curve
?
?
?
DP is the change in price. (DP<0) DQ is the change in quantity. slope = DP/ DQ
Price
Demand
DP slope ? DQ
DP DQ
P P+ DP
Q
Q + DQ
Quantity
Elasticity: Mathematical Definition
DP slope ? DQ
1 DQ ? slope DP
P 1 elasticity ? Q slope
Slope Compared to Elasticity
?
?
The slope measures the rate of change of one variable (P, say) in terms of another (Q, say). The elasticity measures the percentage change of one variable (Q, say) in terms of another (P, say).
Example Elasticity Calculation
? ? ?
Price
?
? ?
Slope = (40-32)/(10-14)=-2 1/slope = -1/2 P/Q = 36/12 = 3 at point A P/Q x 1/slope = -1.5 Elasticity of demand = -1.5 Absolute value of the elasticity = 1.5
Linear Demand Curve
42 41 40 39 38 37 36 35 34 33 32 31 30 10 11 12 13 14
A
Quantity
Exercise: Linear Demand
?
? ? ? ?
Compute the elasticity at the point indicated in red on the table (Q=18,P=24). Slope = -2 1/Slope = -1/2 P/Q = 24/18 = 4/3 Elasticity = -2/3
Quantity 10 11 12 13 14 15 16 17 18 19 20
Price 40 38 36 34 32 30 28 26 24 22 20
Demand Elasticities
?
? ?
Price elasticity of demand is always negative. Economists usually refer to the price elasticity of demand by its absolute value (ignore the negative sign). So, even though the formula says that the price elasticity of demand is negative, we would say the elasticity of demand is 1.5 in the first example and 0.67 in the second.
Elasticities and Linear Demand
Linear Demand Exact Elasticity -1.7273 -1.5000 -1.3077 -1.1429 -1.0000 -0.8750 -0.7647 -0.6667 -0.5789 Quantity 10 11 12 13 14 15 16 17 18 19 20 Price 40 38 36 34 32 30 28 26 24 22 20 Slope -2 -2 -2 -2 -2 -2 -2 -2 -2 1/Slope -0.5 -0.5 -0.5 -0.5 -0.5 -0.5 -0.5 -0.5 -0.5
?
The elasticity varies along a linear demand (or supply) curve. This is illustrated in the linear demand curve table above.
Elasticity
Price (£)
The demand curve can be a range of shapes each of which is associated with a different relationship between price and the quantity demanded.
Quantity Demanded
Elasticity
Price
Totalimportance of elasticity The revenue is price x quantity sold. In this is the information it example,on the£5 x 100,000 provides TR = effect on = £500,000. of changes in total revenue price. This value is represented by the grey shaded rectangle.
£5
Total Revenue
D 100 Quantity Demanded (000s)
Elasticity
Price
If the firm decides to decrease price to (say) £3, the degree of price elasticity of the demand curve would determine the extent of the increase in demand and the change therefore in total revenue.
£5
£3
Total Revenue
D
100 140 Quantity Demanded (000s)
Elasticity
Price (£) 10
Producer decides to lower price to attract sales
% ? Price = -50% % ? Quantity Demanded = +20% Ped = -0.4 (Inelastic) Total Revenue would fall
5
Not a good move!
D
5 6
Quantity Demanded
Elasticity
Price (£)
Producer decides to reduce price to increase sales % ? in Price = - 30% % ? in Demand = + 300% Ped = - 10 (Elastic) Total Revenue rises Good Move!
D
10 7
5
Quantity Demanded
20
Elasticity
?
?
?
If demand is price elastic: Increasing price would reduce TR (%? Qd > % ? P) Reducing price would increase TR (%? Qd > % ? P)
?
?
?
If demand is price inelastic: Increasing price would increase TR (%? Qd < % ? P) Reducing price would reduce TR (%? Qd < % ? P)
Elasticity
?
Income Elasticity of Demand:
? The
responsiveness of demand to changes in incomes
Normal Good – demand rises as income rises and vice versa ? Inferior Good – demand falls as income rises and vice versa
?
Elasticity
?
Income Elasticity of Demand:
A positive sign denotes a normal good A negative sign denotes an inferior good
? ?
Elasticity
?
?
?
?
?
For example: Yed = - 0.6: Good is an inferior good but inelastic – a rise in income of 3% would lead to demand falling by 1.8% Yed = + 0.4: Good is a normal good but inelastic – a rise in incomes of 3% would lead to demand rising by 1.2% Yed = + 1.6: Good is a normal good and elastic – a rise in incomes of 3% would lead to demand rising by 4.8% Yed = - 2.1: Good is an inferior good and elastic – a rise in incomes of 3% would lead to a fall in demand of 6.3%
Elasticity
Cross Elasticity: ? The responsiveness of demand of one good to changes in the price of a related good – either a substitute or a complement
?
% ? Qd of good t __________________ Xed = % ? Price of good y
Elasticity
?
Goods which are complements:
? Cross
Elasticity will have negative sign (inverse relationship between the two) Elasticity will have a positive sign (positive relationship between the two)
?
Goods which are substitutes:
? Cross
Elasticity
?
Price Elasticity of Supply:
? The
responsiveness of supply to changes in price ? If Pes is inelastic - it will be difficult for suppliers to react swiftly to changes in price ? If Pes is elastic – supply can react quickly to changes in price
Pes =
% ? Quantity Supplied ____________________ % ? Price
Determinants of Elasticity
?
?
? ?
Time period – the longer the time under consideration the more elastic a good is likely to be Number and closeness of substitutes – the greater the number of substitutes, the more elastic The proportion of income taken up by the product – the smaller the proportion the more inelastic Luxury or Necessity - for example, addictive drugs
Importance of Elasticity
Relationship between changes in price and total revenue ? Importance in determining what goods to tax (tax revenue) ? Importance in analysing time lags in production ? Influences the behaviour of a firm
?
doc_590767226.pptx
concept of elasticity, degree of elasticity, price elasticity, income elasticity of demand, cross elasticity, determinants of elasticity, importance of elasticity.
Elasticity of Demand
Elasticity: the Concept
?
?
? ? ? ?
?
The responsiveness of one variable to changes in another When price rises, what happens to demand? Quantity demanded falls BUT! How much does demand fall? “Elasticity” is a (standard) measure of the degree of sensitivity (or responsiveness) of one variable to changes in another variable. The elasticity measure is a ratio between two percentage measures: percentage change in one variable over the percentage change in another variable
Elasticity of Demand
Price elasticity of demand: The (self) price elasticity of demand is a measure of the degree of sensitivity of demand to changes in the (self) price, ceteris paribus. ? 2 situations: ? Where % change in quantity demanded is greater than % change in price – elastic ? Where % change in quantity demanded is less than % change in price - inelastic
?
Degrees
?
Perfectly elastic demand
?
?
?
ep=? (in absolute terms) Unlimited quantities can be sold at the prevailing price and even a negligible increase in price would result in zero quantity demanded Perfectly elastic demand curve is a horizontal line, parallel to the quantity axis ep>1 (in absolute terms), A proportionate change in quantity demanded is more than a proportionate change in price Flatter demand curve ep =1 (in absolute terms) Rectangular hyperbola, asymptotic to the axes Uncommon in real life
?
Highly elastic demand
? ? ?
?
Unitary elastic demand:
? ? ?
Degrees
?
Relatively inelastic demand:
? ep<1
(in absolute terms) ? Steeper demand curve ? Necessities, since they are less responsive to a given change in price
?
Perfectly inelastic demand:
? ep=0
(in absolute terms) ? Quantity demanded is totally unresponsive changes in price. ? Neutral goods ? Vertical demand curve, parallel to the price axis
to
Elasticity (more)
% Change in Quantity Demanded ___________________________ % Change in Price
Ped =
If value is between 0 and -1: the relationship is inelastic If value is between -1 and infinity: the relationship is elastic Note: PED has – sign in front of it; because as price rises demand falls and vice-versa (inverse relationship between price and demand)
Size of Price Elasticities
Unit elastic Inelastic
0 1 2 3 4 5
Elastic
6
? ? ?
Unit elastic: price elasticity equal to 1 Inelastic: price elasticity less than 1 Elastic: price elasticity greater than 1
General Formula for Price Elasticity
?
? ? ?
P = Current price of a good Q = Quantity demanded at that price DP = Small change in the current price DQ = Resulting change in quantity demanded
PercentageChange in Quantity Demanded Elasticity ? PercentageChange in Price
DQ Elasticity ? Q
d ln Q ? DP d ln P P
Slope of the Demand Curve
?
?
?
DP is the change in price. (DP<0) DQ is the change in quantity. slope = DP/ DQ
Price
Demand
DP slope ? DQ
DP DQ
P P+ DP
Q
Q + DQ
Quantity
Elasticity: Mathematical Definition
DP slope ? DQ
1 DQ ? slope DP
P 1 elasticity ? Q slope
Slope Compared to Elasticity
?
?
The slope measures the rate of change of one variable (P, say) in terms of another (Q, say). The elasticity measures the percentage change of one variable (Q, say) in terms of another (P, say).
Example Elasticity Calculation
? ? ?
Price
?
? ?
Slope = (40-32)/(10-14)=-2 1/slope = -1/2 P/Q = 36/12 = 3 at point A P/Q x 1/slope = -1.5 Elasticity of demand = -1.5 Absolute value of the elasticity = 1.5
Linear Demand Curve
42 41 40 39 38 37 36 35 34 33 32 31 30 10 11 12 13 14
A
Quantity
Exercise: Linear Demand
?
? ? ? ?
Compute the elasticity at the point indicated in red on the table (Q=18,P=24). Slope = -2 1/Slope = -1/2 P/Q = 24/18 = 4/3 Elasticity = -2/3
Quantity 10 11 12 13 14 15 16 17 18 19 20
Price 40 38 36 34 32 30 28 26 24 22 20
Demand Elasticities
?
? ?
Price elasticity of demand is always negative. Economists usually refer to the price elasticity of demand by its absolute value (ignore the negative sign). So, even though the formula says that the price elasticity of demand is negative, we would say the elasticity of demand is 1.5 in the first example and 0.67 in the second.
Elasticities and Linear Demand
Linear Demand Exact Elasticity -1.7273 -1.5000 -1.3077 -1.1429 -1.0000 -0.8750 -0.7647 -0.6667 -0.5789 Quantity 10 11 12 13 14 15 16 17 18 19 20 Price 40 38 36 34 32 30 28 26 24 22 20 Slope -2 -2 -2 -2 -2 -2 -2 -2 -2 1/Slope -0.5 -0.5 -0.5 -0.5 -0.5 -0.5 -0.5 -0.5 -0.5
?
The elasticity varies along a linear demand (or supply) curve. This is illustrated in the linear demand curve table above.
Elasticity
Price (£)
The demand curve can be a range of shapes each of which is associated with a different relationship between price and the quantity demanded.
Quantity Demanded
Elasticity
Price
Totalimportance of elasticity The revenue is price x quantity sold. In this is the information it example,on the£5 x 100,000 provides TR = effect on = £500,000. of changes in total revenue price. This value is represented by the grey shaded rectangle.
£5
Total Revenue
D 100 Quantity Demanded (000s)
Elasticity
Price
If the firm decides to decrease price to (say) £3, the degree of price elasticity of the demand curve would determine the extent of the increase in demand and the change therefore in total revenue.
£5
£3
Total Revenue
D
100 140 Quantity Demanded (000s)
Elasticity
Price (£) 10
Producer decides to lower price to attract sales
% ? Price = -50% % ? Quantity Demanded = +20% Ped = -0.4 (Inelastic) Total Revenue would fall
5
Not a good move!
D
5 6
Quantity Demanded
Elasticity
Price (£)
Producer decides to reduce price to increase sales % ? in Price = - 30% % ? in Demand = + 300% Ped = - 10 (Elastic) Total Revenue rises Good Move!
D
10 7
5
Quantity Demanded
20
Elasticity
?
?
?
If demand is price elastic: Increasing price would reduce TR (%? Qd > % ? P) Reducing price would increase TR (%? Qd > % ? P)
?
?
?
If demand is price inelastic: Increasing price would increase TR (%? Qd < % ? P) Reducing price would reduce TR (%? Qd < % ? P)
Elasticity
?
Income Elasticity of Demand:
? The
responsiveness of demand to changes in incomes
Normal Good – demand rises as income rises and vice versa ? Inferior Good – demand falls as income rises and vice versa
?
Elasticity
?
Income Elasticity of Demand:
A positive sign denotes a normal good A negative sign denotes an inferior good
? ?
Elasticity
?
?
?
?
?
For example: Yed = - 0.6: Good is an inferior good but inelastic – a rise in income of 3% would lead to demand falling by 1.8% Yed = + 0.4: Good is a normal good but inelastic – a rise in incomes of 3% would lead to demand rising by 1.2% Yed = + 1.6: Good is a normal good and elastic – a rise in incomes of 3% would lead to demand rising by 4.8% Yed = - 2.1: Good is an inferior good and elastic – a rise in incomes of 3% would lead to a fall in demand of 6.3%
Elasticity
Cross Elasticity: ? The responsiveness of demand of one good to changes in the price of a related good – either a substitute or a complement
?
% ? Qd of good t __________________ Xed = % ? Price of good y
Elasticity
?
Goods which are complements:
? Cross
Elasticity will have negative sign (inverse relationship between the two) Elasticity will have a positive sign (positive relationship between the two)
?
Goods which are substitutes:
? Cross
Elasticity
?
Price Elasticity of Supply:
? The
responsiveness of supply to changes in price ? If Pes is inelastic - it will be difficult for suppliers to react swiftly to changes in price ? If Pes is elastic – supply can react quickly to changes in price
Pes =
% ? Quantity Supplied ____________________ % ? Price
Determinants of Elasticity
?
?
? ?
Time period – the longer the time under consideration the more elastic a good is likely to be Number and closeness of substitutes – the greater the number of substitutes, the more elastic The proportion of income taken up by the product – the smaller the proportion the more inelastic Luxury or Necessity - for example, addictive drugs
Importance of Elasticity
Relationship between changes in price and total revenue ? Importance in determining what goods to tax (tax revenue) ? Importance in analysing time lags in production ? Influences the behaviour of a firm
?
doc_590767226.pptx