Download elasticity of demand

ELASTICITY OF DEMAND
 PRICE ELASTICITY OF DEMAND
 CROSS ELASTICITY OF DEMAND
 INCOME ELASTICITY OF DEMAND
Price elasticity of Demand
Measures responsiveness of changes in quantity
demanded to changes in price.
Price increases always cause a decrease
in quantity demanded (law of demand).
BUT
For different products, the degree of
responsiveness varies from elastic (very
responsive) to inelastic (not very
responsive).
This responsiveness can be measured in a
number of ways
Total revenue method
d
p
p
d
p
d
A
q
B
q
q
C
Consider products A, B and C. Price rises by the same amount for
each.
Quantity demand falls for each - but by a different amount.
In A, total revenue (P*Q) has increased after the price rise. In B, TR
has remained the same and in C, TR has fallen.
A is inelastic
B is unitary
C is elastic
TOTAL REVENUE METHOD
Demand
Price Increase
Price Decrease
Elastic
Total revenue will
decrease
Total revenue will increase
Inelastic
Total revenue will
increase
Total revenue will decrease
 IF PRICE AND TOTAL
REVENUE MOVE IN THE
SAME DIRECTION THEN
INELASTIC
DEMAND
 IF PRICE AND TOTAL
REVENUE MOVE IN
OPPOSITE DIRECTIONS
THEN
ELASTIC
DEMAND
ELASTICITY COEFFICIENT
Percentage Change Method
Mid Point Method
 Ed = %Qd / %P
 Ed =
 Use this method if you do not
have both prices and both
quantity demands.
Qd
Q1+Q2
X
P1+P2
P
This method is more accurate.
Use it if you have both
quantities and both prices.
ELASTICITY AT A POINT
P
Z
P
Z
X
X
Y
Y
Q
Q
To calculate elasticity of demand at point X, measure the distance XY
and divide by the distance XZ. If the demand function is a curve you
need to draw a tangent line at the point on the curve.
Elastic and Inelastic Demand Curves
Relatively Elastic
Relatively Inelastic
Price($)
Price($)
Quantity
Shows that a change in
price will result in a
proportionately small
change in demand
Quantity
Shows that a change in
price will result in a
proportionately larger
change in demand
SPECIAL CASES
P
D
Ed=0
Ed=
P
D
Q
Q
PERFECTLY INELASTIC.
PERFECTLY ELASTIC
A change in price brings
about no response - no
change in quantity demand.
A change in price brings about
an infinite response in quantity
demand.
WHY INELASTIC?
 A necessity - either
real or reputed.
 No close substitutes.
 A small % of income
spent on it.
 Non-durable
 Government regulation
makes it a compulsory
purchase.
WHY ELASTIC ?
Many substitutes
A luxury
A high % of income
spent on it.
Durable
Workbooks page 113
CROSS ELASTICITY OF DEMAND
Measures the responsiveness of quantity demanded of
one product to changes in the price of another.
 The sign of the coefficient (+ or -) is important.
 Ecross =
%Qa
%Pb or
 What would the equation be for the midpoint method?
Ecross Coefficient
If Ecross < -1
then it indicates
that the two
products are
complements.
The lower the
number the
stronger the
complementary
relationship.
Ecross Coefficient
If Ecross >1 it
indicates that the
two products are
substitutes. The
higher the
number the closer
the substitute
relationship.
Income elasticity of demand
Measures the responsiveness of a change in quantity
demanded to a change in income
 E= %Qd
%Y
 What would the equation
be for the midpoint
method?
INFERIOR GOODS
Qd
E<0
Income inelastic
Income
NORMAL GOODS
Qd
Qd
0<E<1
E>1
income
Income elastic
Luxury goods
income
Income inelastic
Necessity
GIVE REASONS
This person needs
new windscreen
wipers before she
gets her car
registered.
Comment on the
price elasticity.
Give 4 reasons.
EXPLAIN
As a persons
income increases
the % of their
income that they
spend on food
falls.
True or false?
Explain why.
Vocabulary
 Measures responsiveness
of demand to changes in
price of another good.
 A good with negative
income elasticity.
Cross
elasticity
Inferior
goods
Vocabulary
 Measures responsiveness
of quantitydemand to
changes in price.
 Measures responsiveness
of quantity demand to
changes in income
Price elasticity
Of demand
Income elasticity
Of demand