Download Pε D < 1

Econ 206(A) Tutorial 3
Price Elasticity of Demand
• Relationship between a change in price and the
change in demand.
• The more elastic is demand the greater the change
in quantity demanded for a given change in price.
Computing Price Elasticities of
Demand
%QD
P D 
%P
• PεD = 0, perfectly inelastic (quantity does not change with price)
• PεD → ∞, perfectly elastic (quantity changes infinite amount with
small change in price)
• PεD < 1, inelastic (quantity changes smaller amount (%) then the change in
price (%))
• PεD >1, elastic
(quantity changes larger amount (%) then the change in
price (%))
(a)
P
(b)
D
P
D
Q
Q
(d)
(c)
P
P
D
Q
D
Q
Numerical Examples
• PεD = -0.3;
– inelastic
• PεD = -1.4;
– elastic
• PεD = -0.5;
– inelastic
• PεD = -3.2;
– elastic
– Only absolute values matter (i.e. ignore the `-’ sign).
– We usually expect quantity to go down as price goes up (law of
demand), hence negative sign
Seminar Topic 1
1. Discuss how changes in incomes,
tastes and substitutes may affect the
elasticity of demand.
Substitutes and Income
• Goods with no close substitutes have
highly inelastic demand.
• The higher the proportion of income
spend on a good the greater the
reduction in consumption if prices
increase (more elastic).
Seminar Topic 2
• What does the elasticity of demand
suggest about the potential for indirect
taxes on products such as alcohol,
cigarettes and petrol?
Seminar Topic 3
• Distinguish between the income and
substitution effects of a price change for
a normal good.
Income and Substitution Effects
• As price of a good rises, the purchasing
power of income falls. Hence individuals can
afford less of the good (Income Effect).
• As a price of a good rises, substitute goods
become relatively more attractive. Individuals
demand more substitutes and less of the
initial good (Substitution Effect).
Price elasticity of supply
• The responsiveness
of quantity supplied
to a change in price.
% QS
P S 
% PS
Income elasticity of demand
• The responsiveness of demand to a change in
consumer income Y.
% QD
Y D 
% Y
• If YεD > 1 then a luxury.
• If 0<YεD < 1 then a necessity.
• If YεD < 0 then a inferior good.
Cross elasticity of demand
• How does demand for one good
A respond to a change in the
price of another good B.
C DA,B
>0
(+ve) B is a substitute for A
C DA,B
<0
(-ve) B is a complement for A
C DA ,B 
%QDA
%PB