Download Elasticity of Demand and Supply

Elasticity of Demand and
Supply
Joudrey
Elasticity of Demand
• The formula that measures the actual change in quantity demanded
for a product whose price has changed is the price elasticity of
demand.
• Coefficient of demand elasticity = % change in quantity demanded
•
% change in price
Example
• Gas sells for $0.50/liter and quantity demanded is 10 million liters
each month. Then gas went up to $0.54/liter and quantity demanded
went down to 9.5 million liters. Is gas considered elastic or inelastic?
• To Solve:
• Step 1: calculate the % change in quantity demanded:
• Difference in quantity
9.5-10
x 100% = 5.13%
Average quantity
(9.5+10)/2
• We dropped the negative becasue we are interested in the change
not the direction
Example Cont.
• Step 2: find the % change in price
• Difference in price
0.54-0.5
Average price
(0.54+0.50)/2
x100 =7.69%
Example Cont.
• Step 3: plug in the answers you found in Step 1 and Step 2 into your
formula:
• Coefficient of demand elasticity = % change in quantity demanded
•
% change in price
• Coefficient of demand elasticity = 5.13% = 0.667
•
7.69%
Making Sense of your Answer
• Any coefficient between 0 and 1 has an Inelastic Coefficient. This
means that given a percentage change in price there will be a smaller
percentage change in quantity demanded.
• In our example a 7.69% change in price resulted in a 5.13% change in
quantity demanded.
• As prices change for inelastic items the quantity demanded does not
change as much (ex. Think of essential items or items that are
inexpensive like a pencil).
Another Example
• If price rose from $0.66/liter to $0.70/liter and demanded decreased
from 8 million liters to 7.5 million liters determine the coefficient of
demand elasticity to determine if this product has an inelastic or
elastic coefficient.
• Remember elastic coefficients are greater than 1
• Unitary coefficients are equal to 1
• Inelastic coefficients are less than 1
Answer
• Step 1: % change in Q Demanded =7.5-8
= -0.5 x100 = 6.45%
•
(7.5+8)/2
7.75
• Step 2: % change in Price = 0.7 – 0.66
= 0.04x 100%
=5.88%
•
(0.7+0.66)/2
0.68
• Step 3: Coefficient of Demand Elasticity = 6.45% = 1.10
•
5.88%
• Since the coefficient of demand elasticity is greater than 1 this item
has an elastic demand. 5.88% change in price results in a 6.45%
change in quantity demanded.
• An elastic coefficient (greater than one) means a percentage change
in price causes a greater percentage change in quantity demanded.
• Elastic items (ex. Luxury, expensive items, items with substitutes or
alternatives)
• Unitary coefficient – when it is equal to one. Meaning a percentage
change in price results in an equal percentage change in quantity
demanded.
Coefficient Related to Revenue
• The coefficient will also tell you if the revenue will increase, decrease
or stay the same.
• Inelastic coefficient (between 0 and 1) revenue will rise
• Elastic coefficient (greater than 1) revenue will decrease
• Unitary coefficient (exactly one) revenue will stay the same
Proof
• Inelastic:
• 10 million liters x $0.50/liter = $5 million
• 9.5 million liters x $0.54/liter = $5.13 million
• Resulting in an increase in revenue
• Elastic:
• 8 million liters x $0.66/liter = $5.28 million
• 7.5 million liters x $0.70/liter = $5.25 million
• Resulting in an decrease in revenue
Elasticity of Supply
• The concept of elasticity applies to the demand side as well as the
supply side.
• Generally as prices rise sellers will want to supply more because this
will increase their profits.
• The concept of elasticity of supply measures how responsive the
quantity supplied by a seller is to a rise of fall in price. This is
determined by the formula:
• Coefficient of supply elasticity = % change in quantity supplied
•
% change in price
Example
• The market price of steel increases from $120/tonne to $140/tonne.
The steel manufacturing company increases production from 1 million
tonnes per day to 1.2 million tonnes.
• Step 1: calculate the percentage change in quantity supplied:
• = difference in quantity supplied = 1.2-1 x100%
= 18.18%
•
Average quantity
(1.2+1)/2
Example Continued
• Step 2: Calculate the % change in price:
• Difference in price
= 140-120
x 100%
= 15.38%
• Average price
(140+120)/2
• Step 3: Plug the two answers you just found into your formula:
• Coefficient of supply elasticity= % change in Q. Supplied=18.18%=1.18
•
% change in price
15.38%
• If coefficient is: less than one – inelastic
• Greater than one – elastic
• Equal to one - unitary
Making Sense of the Answer
• The steel manufacturer’s ability to increase production supplied is
elastic within this price range.
• This means that when price increases by a certain % (in our example
15.38%) then manufacturer is able to increase quantity supplied at an
even greater rate (in our example 18.18%)
In General
• A seller with an elastic supply can take more of an advantage of price
increases than a seller with an inelastic supply. This means when the
price of what company A is selling goes up, if company A has an
elastic supply they can make more items to sell at the higher price,
increasing their revenue.
Video
• www.khanacademy.org/economics-financedomain/microeconomics/elasticity-tutorial/price-elasticitytutorial/v/price-elasticity-of-demand