3. eco162- elasticity

8/2/2019 3. ECO162- Elasticity

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MICROECONOMICS

ECO162ELASTICITY

Ms. Tai Nyuk Chin


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LEARNING OUTCOMES

At the end of this lesson, the studentsshould be able to:

i. Explain the concept of elasticity.

ii. Identify the types of elasticity.

iii. Identify the determinants of elasticity ofdemand and supply.

iv. Define and calculate elasticity of demand(price, income, cross) and supply.


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ELASTICITY

Four types of Elasticity:

i. Price Elasticity of Demand

ii. Income Elasticity of Demandiii. Cross-Price Elasticity of Demand

iv. Price Elasticity of Supply


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PRICE ELASTICITY OF DEMAND

1. Definition It is a measure of how much the quantity

demanded of a good responds to a change inthe price of that good.

The percentage change in quantity demanded divided bythe percentage change in a goods price.

2. Measurement :percentage change in demand

percentage change in price

Q1 = Current quantity P1 = Current Price

Qo = base year quantity Po = Price base year

[(Q1-QO/QO)]

[(P1-PO/PO)]

x 100

x 100

Ed =

Ed =


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Computing the Price Elasticity ofDemand

priceinchangePercentage

demandedquatityinchangePercentagedemandofelasticityPrice

Example: If the price of an ice cream cone increases from

$2.00 to $2.20 and the amount you buy falls from 10 to 8cones then your elasticity of demand would be calculated as:

2

2

%10

%20

10000.2

)00.220.2(

10010

)108(

:.Negative sign is ignored since its only indicates the law ofdemand( P increase, Qd decrease and vice versa)


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PRICE ELASTICITY OF DEMAND

How responsive is quantity demanded to pricechanges?

Does quantity demanded change a lot, little, notat all?

There is five degree of elasticity to describehow responsive demand is;

i. Elasticii. Inelastic

iii. Perfectly Elasticiv. Perfectly Inelasticv. Unit Elastic

6


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Figure 6: Degree of Elasticity (Elastic demand)

(a) Elastic Demand: Elasticity Is Greater Than 1, Ed > 1

Demand

Quantity

4

1000

Price

$5

50

1. A 25%increasein price . . .

2. . . . leads to a 50% decrease in quantity demanded.

% Qd > %PElasticity, Ed>1


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Figure 7: Degree of Elasticity (Inelastic Demand)

(b) Inelastic Demand: Elasticity Is Less Than 1, Ed < 1

Quantity0

$5

90

Demand1. A 25%increasein price . . .

Price

2. . . . leads to an 10% decrease in quantity demanded.

4

100

% Qd < %PElasticity, Ed


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Figure 8: Degree of Elasticity (Perfectly Elastic)

(c) Perfectly Elastic Demand: Elasticity Equals Infinity

Quantity0

Price

$4 Demand

2. At exactly $4,consumers willbuy any quantity.

1. At any priceabove $4, quantity

demanded is zero.

3. At a price below $4,quantity demanded is infinite.

Elasticity, Ed =


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Figure 9: Degree of Elasticity (Perfectly Inelastic)

(d) Perfectly Inelastic Demand: Elasticity Equals 0, Ed = 0

$5

4

Quantity

Demand

1000

1. Anyincreasein price . . .

2. . . . leaves the quantity demanded unchanged.

Price Elasticity, Ed = 0%P, %Q = 0


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Figure 10: Degree of Elasticity (Unit Elastic)

2. . . . leads to a 25% decrease in quantity demanded.

(e) Unit Elastic Demand: Elasticity Equals 1

Quantity

4

1000

Price

$5

80


Demand

Elasticity, Ed = 1%P = %Q


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Determinants ofPrice Elasticity of Demand

i. The existence of substitutes

Goods with close substitutes tend to have moreelastic demand because it is easier for consumer tochange from those goods to others.

If there are no substitutes exist, the price elasticity ofdemand tends to be inelastic.

E.g.: Coca cola and Pepsi can easily substitute eachother. Thus, a small increase in the price of Coca cola,assuming price of Pepsi remain constant, will cause thequantity of Coca cola sold to decrease by a largeamount. This is because, consumer will purchase Pepsirather than Coca cola.


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ii. Necessities vs. Luxuries

Necessities goods tend to have inelastic demands,whereas luxuries goods tend to have elastic demands.

E.g.: Price elasticity of demand for Rolex watch iselastic as Rolex watch is considered as a luxury goods.On the other hand, rice which is a necessities good tendto have more inelastic demand.

When price of Rolex increase, there will be a largedecrease in quantity demanded but if price of riceincrease, people dont dramatically alter theconsumption of rice since rice is necessities goods.


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iii. Time horizon.

Goods tend to have more elastic demand over a longerperiod of time horizons.

The shorter the time period, the more inelastic demand

will become. This is because you will have more time to find

substitutes.

E.g.: When the price of fuel increase, the quantity

demanded for fuel falls slightly in the first few months.Thus the demand in short run is inelastic. However, inlonger period, people will find alternative for fuel suchas fuel-efficient cars. Thus, demand tend to be moreelastic.


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iv. Proportion ofconsumers expenditure

Demand tends to be more elastic when aconsumers expenditure on the product is large

and vice versa. E.g.: Demand is more elastic for products such

as cars as consumers proportion for cars islarge while demand for grocery items tend tobe inelastic as the proportion for this items issmaller.


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Total revenue is the amount paid bybuyers and received by sellers of a good.

Computed as the price of the good timesthe quantity sold.

Price Elasticity of Demand andTotal Revenue (TR)

Total Revenue (TR) = Price (P) x Quantity (Q)TR = P x Q


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Figure 11: Total Revenue

Demand

Quantity

Q

P

0

Price

P Q= $400

(revenue)

$4

100


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Elasticity and Total Revenue along aLinear Demand Curve

With an inelastic demand curve, anincrease in price leads to a decrease inquantity that is proportionately smaller.

Thus, total revenue increases.

Fi H T t l R Ch Wh P i


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Figure 12 How Total Revenue Changes When PriceChanges: Inelastic Demand

Demand

Quantity0

Price

Revenue = $100

Quantity0

Price

Revenue = $240

Demand$1

100

$3

80

An Increase in price from $1to $3

leads to an Increase intotal revenue from $100 to$240


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Elasticity and Total Revenue along aLinear Demand Curve

With an elastic demand curve, an increasein the price leads to a decrease in quantitydemanded that is proportionately larger.

Thus, total revenue decreases.

Fi H T t l R Ch Wh P i


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Figure 13 How Total Revenue Changes When PriceChanges: Elastic Demand

Demand

Quantity0

Price

Revenue = $200

$4

50

Demand

Quantity0

Price

Revenue = $100

$5

20

An Increase in price from $4to $5

leads to an decrease intotal revenue from $200 to$100


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Cross Price Elasticity of Demand

Elasticity measure that looks at the impact of a change inthe price of one good has on the demand of anothergood.

Positive: P of Good A increase, Qdd of Good Bincrease (Substitutes goods)

Negative: P of Good A increase, Qdd of Good Bdecrease (Complement goods)

% change in demand Qx% change in price of Qy

[(Q1x-Q0x/Q0x)]

[(P1y-P0y/P0y)]

Ec =

Ec =


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The Cross Price elasticity of demand for good X if price of Good Xincrease from RM10 to RM12:

Cross Price Elasticity of Demand

Price ofGood X

(RM)

Qd forGood Y(Unit)

Qd forGood Z(Unit)

10 100 100

12 110 70

% change in Qd Good X% change in price of Good Y

[(Qdy 1-Qdy 0/Qdy 0)]

[(Px1-Px 0/Px 0)]

Ec =

Ec = x 100

x 100

x 100

x 100

Ec = (110 -100 / 100)( 12-10/10)

= [10/ 20]= 0.5 (Substitutes good)

:. Positive value indicates thatgood X and Good Y is asubstitutes goods

x 100

x 100

Ec = (70 -100 / 100)(12-10/10)

= [-30/ 20]= - 1.5 (Complement good)

:. Negative value indicates thatGood X and Good Z is acomplement goods

Good X and Good Y: Good X and Good Z:

x 100

x 100


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Income Elasticity of Demand

Income elasticity of demand measures howmuch the quantity demanded of a good respondsto a change in consumers income.

It is computed as the percentage change in thequantity demanded divided by the percentagechange in income.

% change in demand Q% change in Income

[(Q1-Q0/Q0)]

[(Y1-Y0/Y0)]

Ey=

Ey=


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Income Elasticity of Demand

Types of Goods

i. Normal Goods

Income Elasticity is positive.

ii. Inferior GoodsIncome Elasticity is negative.

Higher income raises the quantity demanded fornormal goods but lowers the quantity demanded

for inferior goods.


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Ey = [(110 -100) / 100]

[ (150-100)/100]

= [10/ 50]

= 0.2 (Normal good)

:. Positive value of Ey indicatesthat good X is a normal goods.

:. If income increases by 1%,quantity of good X demandedwill increase by 0.2%

Income Elasticity of DemandIncome

(RM)

Qd for

Good X(Unit)

Qd for

Good Y(Unit)

100 100 100

150 110 70

% change in demand Q

% change in Income

[(Q1-Q0/Q0)]

[(Y1-Y0/Y0)]

x 100

x 100

Ey =

Ey = x 100

x 100

x 100

x 100

Ey = [(70 -100) / 100]

[(150-100)/100]

= (-30/50 )

= - 0.6 (Inferior good)

:. Negative value of Ey indicatesthat good Y is a inferior goods.

:. If income increases by 1%,quantity of good Y demandedwill decrease by 0.6%

x 100

x 100

The income elasticity of demand for good X if

income increase from RM100 to RM150:

The income elasticity of demand for good Y if

income increase from RM100 to RM150:


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THE ELASTICITY OF SUPPLY

Price elasticity of supply is a measure of how much thequantity supplied of a good responds to a change in the priceof that good.

Price elasticity of supply is the percentage change in quantity

supplied resulting from a percent change in price.

Q1 = Current quantity P1 = Current Price

Qo = base year quantity Po = Price base year

Percentage change in quantity supplied

Percentage change in price

[(Q1-Q0/Q0)]

[(P1-P0/P0)]

Es =

Es =x 100

x 100


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Figure 14 The Price Elasticity of Supply (Elastic Supply)

(a) Elastic Supply: Elasticity Is Greater Than 1 (Es > 1)

Quantity0

Price


2. . . . leads to a 50% increase in quantity supplied.

4

100

$5

200

Supply

%P

3. eco162- elasticity

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