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DEMAND AND SUPPLY
DEMAND AND SUPPLY
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Price Elasticity of Demand
“Measures the degree of responsiveness of the
quantity demanded of a commodity to changes in
its prices, ceteris paribus. It involves a movement
along the demand curve in response to price
change”
Tutorial Notes
DEMAND AND SUPPLY
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Price Elasticity of Demand
PED of a Good A = %
%
quantity demanded of good A
in price of good A
Tutorial Notes
DEMAND AND SUPPLY
Price Elasticity of Demand
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Price Elasticity of 2 Product/Service In India
P
P1
P
P0
D1
D0
Q
Q1
Q2
DEMAND AND SUPPLY
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Price Elasticity of Demand (PED)
Quantity Demanded For 2 Types of Food Rice Vs Burgers in India
P
P
Rice
Inelastic
Burger
Elastic
P1
P1
Rev.
Gained
Rev. Gained
P0
Q1
D
Q0
Q
Q
Before P Increased, Revenue = P0XQ0
After P increased, Revenue = P1XQ1
2. For the producer of rice, his lost in
revenue, red shade, is lesser than the
revenue gained (yellow shade) when
price is increased for rice.
3. This however is not
the same for the
burger that is price
elastic in product.
Rev. Lost
Rev. Lost
P0
1. For a price inelastic product, rice in
this example, a big change in price
does not extensively affect the quantity
demanded of the product.
Q1
D
Q0
Q
Q
*Revenues is calculated as PXQ
DEMAND AND SUPPLY
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Factors that Influence PED
Availability of Substitutes
-The more substitutes there are the
greater the PED ie. the more elastic
the PED of the good. The slope of the
demand curve would not be very
steep.
-The less substitutes there is for the
product, the steeper the slope of the
demand curve.
Time
- When there is a sudden change in
price of say, rice, people cannot react as
fast in the short run so they will still have
to suffer the increase in prices of rice.
This makes the slope of the demand
curve steep. But with time, when
substitute for rice can be found or
perhaps there is a change in taste and
preference for rice, the demand curve
will become less steep.
Proportion of Income Spent
on Commodity
If you only spend a small
portion of your income on the
good like say a pen, the
change in its price by 10% is
not going to make you change
your quantity demand for it by
much as it is cost very little
unlike a car or clothing. So the
slope for these items can be
steep.
P
D1
D0
Qty
Quizz 1 - Teaser
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Q1: The world market for Thai rice has been disrupted by protest against
the government. Simultaneously, demand for rice has also been dropping
owing to the change in taste and preference of the Thai people from rice to
Soya Bean. Using a diagram, explain what will happen to the market price
and quantity demanded for Thai rice. (5 marks)
Answer
1. Draw a demand and supply diagram.
2. On the diagram explain how disruption and
population will shifts the demand and supply curves.
3. You must explain the diagrams by saying,
“Initially market equilibrium is at (P0,QO).
Subsequently owing to a disruption in supply
causing the supply curve to shift to the left and
population increase shifting the demand curve to
the right, this have given rise to a new market
equilibirum for Thai rice of (P1,Q1). The market
clearing price is now higher (causing quantity
demanded to increase less quickly) while the
equilibrium quantity demanded may increase or
decrease depending on the amount of shift of the
demand curve to the right”
P
P1
P0
Q
Q0
Q1
Quizz 2 - Teaser
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Qn: Cigarettes are addictive and the government
intends to curb smoking
by increasing the price of cigarettes through a cigarette tax. Using an
appropriate diagram, explain how the revenues of cigarette producers are
affected after this price increase. (5 marks)
Answer
1. Define price elasticity of demand.
Revenues is calculated as PXQ
P
2. Explain that smoking cigarettes is addictive and
is price inelastic in demand..
3. Draw the diagram on the right. You
Inelastic
P1
Rev. Gained
P0
Rev. Lost
must explain the diagram. Start by saying
“initially the equilibrium price is at P0 and
quantity demanded is at Q0. This gives rise to
total revenue represented by the red shaded
area. After the price has increased, the new
total revenue is given by P1XQ1.”
4. Based on the diagram, it can be seen that the
total revenue gained (yellow shaded areas)
after the price increased is more than total
revenue lost (red shaded areas). As such the
producer actually benefits with greater total
revenues than before as long as his product
sold is prices inelastic in demand.
Cigarettes
Q1
D
Q0
Q
Q
Before P Increased, Revenue = P0XQ0
After P increased, Revenue = P1XQ1
Quizz 3 - Teaser
The price of corn has been increasing relentlessly
ever since the US
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Department of Transport approved biofuel (made by processing corn) as an
alternative fuel to petrol. However, given the fact that many Americans are
addicted to petrol, it is unlikely that drivers will switch to bio fuel in the short
term.
1. Using demand and supply diagram (s) , explain the relationship between
corn and bio-fuel.
2. Using a demand and supply diagram(s), explain the relationship between
bio fuel and petrol.
3. Using a well labeled diagram, explain what the author means by saying
“Americans are addicted to fuel oil”.
Quizz 3 (continued) - Teaser
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Q1. Bio fuel is derived from corn. As such corn is a derived demand good.
This can be illustrated by the diagram below.
Bio Fuel
Corn
Referring to the diagrams, it
can be seen that when there is
an increase in demand for bio
fuel, this will cause the demand
curve for biofuel to shift to the
right. Simultaneously, this will
also cause a shift of the
demand curve to the rigth for
corn as well.
Quizz 3 (continued) - Teaser
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Q2. Petrol and Bio fuel are substitutes. Their relationship can be illustrated
by the diagrams below.
Bio Fuel
Petrol
Referring to the diagrams, it
can be seen that when there is
an increase in demand for bio
fuel, this will cause the demand
curve for bio fuel to shift to the
right. However, this will cause a
shift of the demand curve for
petrol to shift to the left as
there will be less quantity
demanded for petrol as bio fuel
and petrol are substitutes for
each other.
Quizz 3 – Continued.
Q3. Answer:
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Q3. “Adiction” implies that the demand
for petrol for Americans is price elastic in
demand.
When something is price in elastic in
demand it would means that the degree
of change in quantity demand is not as
great as the degree of change in its price
P
Petrol
PED<1
P1
This can be seen from the diagram on the
right. When there is a change in the price
from Po to P1, it is noticed that the
change in quantity demanded only
incrrease by an amount Q0 to Q1 which
is not as great as the degree of change in
its price.
As such, small change in fuel prices will
not immediately cause Americans to
switch over to bio fuel.
P0
D
Q1
Q0
Q
Q