# chapter 5 elasticity.ppt

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In this chapter" loo# $or the ans%ers

to these &uestions'

elasticity help us to understand?

• What is the price elasticity of demand? How is it related to the demand curve?

How is it related to revenue & expenditure?

• What are the income and cross-price elasticities of

demand?

How is it related to the supply curve?

8/9/2019 Chapter 5 elasticity.ppt

Elasticity ( ( (

with greater precision.

respond to changes in market conditions

8/9/2019 Chapter 5 elasticity.ppt

Elastic – stretchy, flexible, ndex of reaction

nelastic – ri!id, inflexible

response to another variable, independent of units"

Elasticity is a numerical measure of the relative

responsiveness of #uantity demanded $Qd % or #uantity

supplied $Qs % to one of its determinants keepin! other

determinants constant"

to a percenta!e chan!e in another variable"

'ar!er the value of elasticity, the more responsiveness is

#uantity demanded to chan!es in the determinant under

consideration

Elasticity ( ( (

E!ASTICIT) *+ ,EA.,

responsiveness of #uantity demanded to chan!es

in one of the determinant, assumin! other

determinants remain unchan!ed

demanded of a commodity in response to )*

chan!e in one of the determinant, assumin! other determinants remain unchan!ed "

8/9/2019 Chapter 5 elasticity.ppt

Copyright © 2004 South-Western/Thoson !earning

E!ASTICIT) *+ ,EA., ' T)ES

+ypes of Elasticity of (emand depends on which determinant brin!s out a chan!e in

#uantity demanded of a commodity

(eterminant of (emand Elasticity of (emand

rice of the .ommodity rice elasticity of demand

ncome of the .onsumer ncome elasticity of demand

rice of /elated .ommodity .ross elasticity of demand 0dvertisement Expenditure romotional elasticity of

demand

demand

rice Elasticity o$ ,eand

• rice elasticity of demand measures how much Qd

responds to a change in P .

Price elasticity

of demand =

buyers! demand.

#uantity demanded of a commodity to a chan!e in

price of the commodity, keepin! other determinants

of demand constant"

rice Elasticity o$ ,eand

Price elasticity

of demand

*long a D cure, P and Q moe

in opposite directions, which

would make price elasticity

negatie.

+e will drop the minus sign and report all price elasticities

as positie numbers.

*long a D cure, P and Q moe

in opposite directions, which would make price elasticity

negatie.

and report all price elasticities

as positie numbers.

because of inverse relationship between price and

#uantity demanded rice elasticity, ep is a ratio of mar!inal demand

d34d to avera!e demand 34

Elasticity is unit less or dimension less concept

+he coefficient of elasticity is ordered accordin! to absolute value as opposed to al!ebraic value" Hence an

elasticity of –1 is !reater than an elasticity of -)

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start alue ( #$$%

1&3$25$ = &%

different answers depending on

elasticity = 995& = #.99

end alue 3 start alue

midpoint ( #$$%

start : end alues, the aerage of those alues.

6t doesn!t matter which alue you use as the ;start<

and which as the ;end< 3 you get the same answer

either way

when calculating the price elasticity of demand

because it gies the same answer regardless of

the direction of the change.

P r i c e e l a s t i c i t y o f d e m a n d = 1 2 5 > 1 2 5 ?

1 2 5 > 1 2 5 ?

Q Q Q Q

P P P P

P# = 6nitial Price

P = Ahanged Price

e"uals

& 3 $ .&

# 3 #$

( #$$% = C$.$%

C$5. = #.

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Calculating rice Elasticity o$ ,eand gien ,eand +unction

d3d

P = $$ 3 @d

*t P = #$, @d = E&, [email protected] 5 dP = - $.&

= = 1-$.&2 F 1#$ 5 E&2 = - $.$&G d3d

d 3 d

6 6 ep

• 6nelastic /emand

price changes.

• 'lastic /emand

price. • Price elasticity of demand is greater than one.

8/9/2019 Chapter 5 elasticity.ppt

related to the slope of the demand cure.

• Dule of thumb) 7he flatter the cure, the bigger the elasticity.

7he steeper the cure, the smaller the elasticity.

• 8ie different classifications of D cures.…

8/9/2019 Chapter 5 elasticity.ppt

P

Q

% change in P =

% change in P =

% change in P =

P

Q

P )

Q)

ICE E!ASTICIT) *+ ,EA., ' A.ES

erfectly nelastic $ep 5 8% 0ny chan!e in price does not brin! any chan!e in #uantity demanded

/elatively nelastic $89ep 9)% roportionate chan!e in

price is !reater than proportionate chan!e in #uantity

demanded :nitary Elastic $ep 5)% roportionate chan!e in price

results an e#ually proportionate chan!e in #uantity

demanded

#uantity demanded is !reater than proportionate chan!e in

price

even if there is no chan!e in price

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• 4eometrical 1/iagrammatic2) Datio of the two segments of the horizontal a(is identified by the intersection of the tangent to the point

considered, with the horizontal a(is and by the perpendicular from that point to the same a(is

• Lower segment of the tangent

Bpper segment of the tangent

ICE E!ASTICIT) *+ ,EA.,' *. A ,EA., C63E

ep 666666666666 66 5

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P

Q $

A

C

B

ep 5 8 4 0; 5 8

ep 5 0. 4 ;. 5 ), . is the mid point of 0;

ep 5 0; 4 8 5 <

ep = )

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ICE E!ASTICIT) *+ ,EA.,' I. A !I.EA ,EA., C363E

>3 73

66 7E

2) 66

5 3)(

Elasticity o$ a !inear ,eand Cure

7he slope of a linear

demand

• Aontinuing our scenario, if you raise your price

from Ds.$ to Ds.&, would your reenue rise or fallK

Deenue = P ( Q

• * price increase has two effects on reenue) • igher P means more reenue on each unit

you sell.

• ut you sell fewer units 1lower Q2, due to Law of /emand.

• +hich of these two effects is biggerK

6t depends on the price elasticity of demand.

8/9/2019 Chapter 5 elasticity.ppt

• 6f demand is elastic, then

price elasticity of demand I #

% change in Q I % change in P

• 7he fall in reenue from lower Q is greater

than the increase in reenue from higher P ,

so reenue falls.

Deenue = P ( Q

'lastic demand 1elasticity = #.2 P

Q

D

Ds.$

+hen D is elastic,

Ds.&

• 6f demand is inelastic, then

price elasticity of demand H #

% change in Q H % change in P

• 7he fall in reenue from lower Q is smaller

than the increase in reenue from higher P ,

so reenue rises.

• 6n our e(ample, suppose that Q only falls to #$ 1instead

of 2 when you raise your price to Ds.&.

Deenue = P ( Q

rice Elasticity and Total eenue

Mow, demand is inelastic)

+hen D is inelastic,

lost

rice Elasticity and Total eenue

rice 3uan tity

& C $ -#. GG.J -9.J Delatiely 'lastic

C G C -. C$.$ -#. Delatiely 'lastic

9 C -.G .G -#.$ Bnitary 'lastic

#$ $ -C$.$ . -$.G Delatiely 6nelastic

# # # -GG.J #. -$.9 Delatiely 6nelastic

$ #C $ -$$.$ #&.C -$.# Delatiely

8/9/2019 Chapter 5 elasticity.ppt

+otal 2utlay or /evenue or Expenditure ethod

ICE E!ASTICIT) *+ ,EA.,' EAS6EE.T

ncrease in

+otal /evenue

(ecrease in

+otal /evenue

7o learn the determinants of price elasticity,

we look at a series of e(amples.

'ach compares two common goods.

6n each e(ample)

• 0uppose the prices of both goods rise by $%.

• 7he good for which Qd falls the most 1in percent2 has

the highest price elasticity of demand. +hich good is itK +hyK

• +hat lesson does the e(ample teach us about the

determinants of the price elasticity of demandK

8/9/2019 Chapter 5 elasticity.ppt

E9A!E :'

Thups-up s( Sugar • 7he prices of both of these goods rise by $%.

8or which good does Qd drop the mostK +hyK

• 7humps-up has lots of close substitutes

1e.g ., Aoca Aola, 0prite2, so buyers can easily switch if the price rises.

• 0ugar has no close substitutes,

so consumers would probably not buy much less if its price rises.

'esson Price elasticity is higher when close

substitutes are available .

E9A!E 2'

;1lue <eans= s( ;Clothing= • 7he prices of both goods rise by $%.

8or which good does Qd drop the mostK +hyK

• 8or a narrowly defined good such as

blue Neans, there are many substitutes

1khakis, shorts, 0peedos2.

defined goods.

1Aan you think of a substitute for clothing, other than liing in a nudist colonyK2

'esson Price elasticity is higher for narrowly

defined goods than broadly defined ones.

8/9/2019 Chapter 5 elasticity.ppt

E9A!E >'

• 7o millions of diabetics, insulin is a necessity.

* rise in its price would cause little or no decrease

in demand.

some people will forego it.

'esson Price elasticity is higher for luxuries than for

necessities. or necessities! it is inelastic.

E9A!E 4'

E9A!E 4'

asoline in the Short un s(

asoline in the !ong un • 7he price of gasoline rises $%. /oes Qd drop more in

the short run or the long runK +hyK

• 7here!s not much people can do in the

short run, other than ride the bus or carpool. • 6n the long run, people can buy smaller cars

or lie closer to where they work.

'esson Price elasticity is higher in the long run than the short run.

The ,eterinants o$ rice Elasticity'

8/9/2019 Chapter 5 elasticity.ppt

The ,eterinants o$ rice Elasticity'

A Suary

the e(tent to which close substitutes are aailable

whether the good is a necessity or a lu(ury

how broadly or narrowly the good is defined

the time horizon) elasticity is higher in the long

run than the short run.

7he price elasticity of demand depends on)

the e(tent to which close substitutes are aailable

whether the good is a necessity or a lu(ury

how broadly or narrowly the good is defined

the time horizon) elasticity is higher in the long

run than the short run.

8/9/2019 Chapter 5 elasticity.ppt

BCthe responsiveness of demand to a chan!e in

consumer income, D

t is computed as the percenta!e chan!e in the #uantity

demanded divided by the percenta!e chan!e in income" f we substitute variable Bincome for variable Bprice,

then the formula for measurin! income-elasticity of

demand is same as for measurin! price-elasticity of

demand

inferior !oods

8/9/2019 Chapter 5 elasticity.ppt

Copyright © 2004 South-Western/Thoson !earning

'(ample) C /O/s demanded [email protected] when consumer!s income 12 is Ds. $$$$. +hen income increased to Ds. &$$$, demand for

/O/ increases to 9$. Aalculate income elasticity of demand. 1use

mid-point method2

*nswer) ey = % Q in @d 5 % Q in

= 119$ -C2519$RC22 5 11&$$$ 3 $$$$2 5 1&$$$R$$$$22 = 1G 5 &C 2 5 1&$$$ 5 C&$$$2 = 1 #5E 2 5 1#5E2 = #

18ind what you are getting using percentage method2 Bnitary income elasticity of demand implying #% increase in

income of the consumer leads to # % increase in "uantity demanded of

/O/ /O/ in "uestion is a normal commodity since income elasticity of

demand is positie

8/9/2019 Chapter 5 elasticity.ppt

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f demand function is !iven $3d is a function of ncome%

Aalculate income elasticity of demand at income leel 12 of Ds.

&$$$ if the demand function is @d = G$$ - $.$

*nswer) *t = &,$$$, "uantity demanded = G$$ - &$$ = #$$

ey =1 [email protected] 5 d2 F 1 5 @2

= 1-2$.$ F 1&$$$ 5 #$$2 = 1-2 & 6ncome elasticity of demand is elastic in nature implying #% increase

in income of the consumer leads to & % decrease in "uantity demanded

of the commodity 7he commodity in "uestion is an inferior commodity since income

elasticity of demand is negatie.

EASS6I. I.C*E E!ASTICIT) *+ ,EA.,

8/9/2019 Chapter 5 elasticity.ppt

@ature of .ommodities and ncome Elasticity of (emand

I.C*E E!ASTICIT) *+ ,EA.,

7oods ncome-elasticity Effect on sale

Essential or @ecessary !oods

.omforts or

unity ore than proportionate increase in sale

8/9/2019 Chapter 5 elasticity.ppt

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BCthe responsiveness of demand of a commodity to a chan!e in the price of its related $substitutes and complementary% commodities

t is computed as the percenta!e chan!e in the #uantity demanded divided by the percenta!e chan!e in the price of substitute or complementary commodities"

ositive cross elasticity Aubstitutes

@e!ative cross elasticity .omplementary commodities

Fero cross elasticity ndependent commodities

+he !reater the absolute value of cross elasticity of demand, the more intense is the relationship existin! between the two !oods

C*SS E!ASTICIT) *+ ,EA.,

EAS6I. C*SS E!ASTICIT)

8/9/2019 Chapter 5 elasticity.ppt

EAS6I. C*SS E!ASTICIT) *+ ,EA.,

'(ample) units of Pizza is demanded [email protected] when the price of urger is Ds. $. +hen price of urger increases to Ds. &,

demand for Pizza increases to C. Aalculate cross elasticity of

demand using mid-point method.

*nswer) eP = % Q in @d of Pizza 5 % Q in Price of urger

= 11C -251CR22 5 11& 3 $2 5 1&R$22

= 1 5 G 2 5 1& 5 C&2 = 1 #59 2 5 1#5E2 = 9

Aross elasticity of demand is elastic in nature, implying #% increase in price of urger leads to 9 % increase in "uantity

demanded of Pizza. Pizza and urger in "uestion are substitute commodities since

cross elasticity of demand is positie.

8/9/2019 Chapter 5 elasticity.ppt

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f demand function is !iven $3d is a function of rice of related commodity%

7he demand function for urger is estimated at

@ = G - $. P7, +here @ = @uantity demanded of urger and P7 is the

Price of 7omato Setchup.

Aalculate cross elasticity of demand at P7 = $. *nswer) *t P7 = $, @ = G - C =

e7 =1 d @ 5 d P72 F 1P7 5 @2

= 1-2$. F 1$ 5 2 = 1-2 Aross elasticity of demand is elastic in nature implying #% increase in Price

of 7omato Setchup leads to % decrease in "uantity demanded for urger urger and 7omato Setchup in "uestion are complementary to each other

since cross elasticity of demand is negatie.

EASS6I. C*SS E!ASTICIT) *+ ,EA.,

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7ime +atch Ao. assembles wrist watches and sells in +estern 6ndia. /emandfunction faced by the Aompany is estimated to be

@ = C$,$$$ 3 Pt 3 R CPc +here, @ = Mumber of watches demanded from 7ime +atch Ao. Pt = Price of watches sold by 7ime +atch Ao.

= Per-capita income in +estern 6ndia Pc = Price charged by Aasio +atch Ao, the competitors Aurrently Pt, 6 and Pc are Ds. 9&$, Ds.#$,$$$ and Ds. C$$ respectiely 'stimate a2Price elasticity of demandT

b26ncome elasticity of demand and comment on nature of productT

c2Aross elasticity of demand and bring how these two watches relates to each other. d2/o you recommend an increase in price if 7imes +atch Ao. wanted to ma(imise sales reenue K Uustify

E!ASTICIT) *+ ,EA.,

Copyright © 2004 South-Western/Thoson !earning

@ = C$,$$$ 3 Pt 3 R CPc +hen Pt, and Pc are Ds. 9&$, Ds.#$,$$$ and Ds. C$$ respectiely, @ = C$,$$$ 3 J$$ 3 $,$$$ R #G$$ = $,E$$

a2 Price elasticity of demand = 1-2 F 19&$ 5 $E$$2 = - J 5 $E = - $.$99CE

b2 6ncome elasticity of demand = 1-2 F 1#$$$$5$E$$2 = - $.EG

Mature of product 3 since ei H $, 6nferior commodity

c2 Aross elasticity of demand = 1C2 F 1C$$5$E$$2 = $.$JGG

Mature of relationship 3 since ei I $, 0ubstitutes

d2es. 0ales can be ma(imised when VD = $ or e p = #.

0ince demand is inelastic, increase in price will increase sales reenue.

E!ASTICIT) *+ ,EA.,

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THE E!"TI#IT$ %& "UPP$

• Price elasticity of supply is a measure of how much the "uantity supplied of a good responds

to a change in the price of that good.

• Price elasticity of supply is the percentage change in "uantity supplied resulting from a

percent change in price.

8/9/2019 Chapter 5 elasticity.ppt

rice Elasticity o$ Supply

much Qs responds to a change in P .

Price elasticity of s'ly

Percenta*e chan*e in Q s

Percenta*e chan*e in P

Loosely speaking, it measures the price-sensitiity of

sellers! supply.

percentage changes.

Q 2

at a price Ds.#$. +hen

price increases to Ds. #&,

$ units is supplied. 8ind

Percenta*e chan*e in Q s

Percenta*e chan*e in P

[email protected]'

Q 2

@s = #$$ R P

*t P = #$, @s = #$, [email protected] 5 dP =

P

Q

S

d3s

es = F 1#$5#$2 = #5G

8/9/2019 Chapter 5 elasticity.ppt

The 3ariety o$ Supply Cures

• 'conomists classify supply cures according to their elasticity.

• 7he slope of the supply cure is closely related

to price elasticity of supply. • Dule of thumb)

7he flatter the cure, the bigger the elasticity.

7he steeper the cure, the smaller the elasticity. • 7he ne(t slides present the different

classifications, from least to most elastic.

8/9/2019 Chapter 5 elasticity.ppt

S

P

S

;Inelastic=

P

S

S

;Elastic=

P

S

P

Q

P :

Q :

The ,eterinants o$ Supply Elasticity

• 7he more easily sellers can change the "uantity they produce, the greater the price elasticity of

supply.

• '(ample) 0upply of beachfront property is harder to ary and thus less elastic than

supply of new cars.

• 8or many goods, price elasticity of supply isgreater in the long run than in the short run,

because firms can build new factories, or

new firms may be able to enter the market.

8/9/2019 Chapter 5 elasticity.ppt

A!ICATI*. o$ E!ASTICIT)

• Aan good news for farming be bad news for farmersK

• +hat happens to wheat farmers and the market

for wheat when uniersity agronomists discoer a new wheat hybrid that is more productie

than e(isting arietiesK

8/9/2019 Chapter 5 elasticity.ppt

TE A!ICATI*. *+ S6!)" ,EA.," A., E!ASTICIT)

• '(amine whether the supply or demand cure shifts.

• /etermine the direction of the shift of the

cure. • Bse the supply-and-demand diagram to see

how the market e"uilibrium changes.

An Increase in Supply in the ar#et $or Wheat

8/9/2019 Chapter 5 elasticity.ppt

Duantity o$

increase in 7'antity sold2 !s a res'lt8

reven'e falls from 96-- to 9::-2

Demand

an increase in s'ly 2 2 2

:

"'mmary

• Price elasticity of demand measures how much the "uantity demanded responds to changes in

the price.

• Price elasticity of demand is calculated as the percentage change in "uantity demanded

diided by the percentage change in price.

• 6f a demand cure is elastic, total reenue falls when the price rises.

• 6f it is inelastic, total reenue rises as the price

rises.

"'mmary

• 7he income elasticity of demand measures how much the "uantity demanded responds to

changes in consumers! income.

• 7he cross-price elasticity of demand measures how much the "uantity demanded of one good

responds to the price of another good.

• 7he price elasticity of supply measures how much the "uantity supplied responds to changes

in the price. .

"'mmary

• 6n most markets, supply is more elastic in the long run than in the short run.

• 7he price elasticity of supply is calculated as

the percentage change in "uantity supplied diided by the percentage change in price.

• 7he tools of supply and demand can be applied

in many different types of markets.

to these &uestions'

elasticity help us to understand?

• What is the price elasticity of demand? How is it related to the demand curve?

How is it related to revenue & expenditure?

• What are the income and cross-price elasticities of

demand?

How is it related to the supply curve?

8/9/2019 Chapter 5 elasticity.ppt

Elasticity ( ( (

with greater precision.

respond to changes in market conditions

8/9/2019 Chapter 5 elasticity.ppt

Elastic – stretchy, flexible, ndex of reaction

nelastic – ri!id, inflexible

response to another variable, independent of units"

Elasticity is a numerical measure of the relative

responsiveness of #uantity demanded $Qd % or #uantity

supplied $Qs % to one of its determinants keepin! other

determinants constant"

to a percenta!e chan!e in another variable"

'ar!er the value of elasticity, the more responsiveness is

#uantity demanded to chan!es in the determinant under

consideration

Elasticity ( ( (

E!ASTICIT) *+ ,EA.,

responsiveness of #uantity demanded to chan!es

in one of the determinant, assumin! other

determinants remain unchan!ed

demanded of a commodity in response to )*

chan!e in one of the determinant, assumin! other determinants remain unchan!ed "

8/9/2019 Chapter 5 elasticity.ppt

Copyright © 2004 South-Western/Thoson !earning

E!ASTICIT) *+ ,EA., ' T)ES

+ypes of Elasticity of (emand depends on which determinant brin!s out a chan!e in

#uantity demanded of a commodity

(eterminant of (emand Elasticity of (emand

rice of the .ommodity rice elasticity of demand

ncome of the .onsumer ncome elasticity of demand

rice of /elated .ommodity .ross elasticity of demand 0dvertisement Expenditure romotional elasticity of

demand

demand

rice Elasticity o$ ,eand

• rice elasticity of demand measures how much Qd

responds to a change in P .

Price elasticity

of demand =

buyers! demand.

#uantity demanded of a commodity to a chan!e in

price of the commodity, keepin! other determinants

of demand constant"

rice Elasticity o$ ,eand

Price elasticity

of demand

*long a D cure, P and Q moe

in opposite directions, which

would make price elasticity

negatie.

+e will drop the minus sign and report all price elasticities

as positie numbers.

*long a D cure, P and Q moe

in opposite directions, which would make price elasticity

negatie.

and report all price elasticities

as positie numbers.

because of inverse relationship between price and

#uantity demanded rice elasticity, ep is a ratio of mar!inal demand

d34d to avera!e demand 34

Elasticity is unit less or dimension less concept

+he coefficient of elasticity is ordered accordin! to absolute value as opposed to al!ebraic value" Hence an

elasticity of –1 is !reater than an elasticity of -)

8/9/2019 Chapter 5 elasticity.ppt

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start alue ( #$$%

1&3$25$ = &%

different answers depending on

elasticity = 995& = #.99

end alue 3 start alue

midpoint ( #$$%

start : end alues, the aerage of those alues.

6t doesn!t matter which alue you use as the ;start<

and which as the ;end< 3 you get the same answer

either way

when calculating the price elasticity of demand

because it gies the same answer regardless of

the direction of the change.

P r i c e e l a s t i c i t y o f d e m a n d = 1 2 5 > 1 2 5 ?

1 2 5 > 1 2 5 ?

Q Q Q Q

P P P P

P# = 6nitial Price

P = Ahanged Price

e"uals

& 3 $ .&

# 3 #$

( #$$% = C$.$%

C$5. = #.

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Calculating rice Elasticity o$ ,eand gien ,eand +unction

d3d

P = $$ 3 @d

*t P = #$, @d = E&, [email protected] 5 dP = - $.&

= = 1-$.&2 F 1#$ 5 E&2 = - $.$&G d3d

d 3 d

6 6 ep

• 6nelastic /emand

price changes.

• 'lastic /emand

price. • Price elasticity of demand is greater than one.

8/9/2019 Chapter 5 elasticity.ppt

related to the slope of the demand cure.

• Dule of thumb) 7he flatter the cure, the bigger the elasticity.

7he steeper the cure, the smaller the elasticity.

• 8ie different classifications of D cures.…

8/9/2019 Chapter 5 elasticity.ppt

P

Q

% change in P =

% change in P =

% change in P =

P

Q

P )

Q)

ICE E!ASTICIT) *+ ,EA., ' A.ES

erfectly nelastic $ep 5 8% 0ny chan!e in price does not brin! any chan!e in #uantity demanded

/elatively nelastic $89ep 9)% roportionate chan!e in

price is !reater than proportionate chan!e in #uantity

demanded :nitary Elastic $ep 5)% roportionate chan!e in price

results an e#ually proportionate chan!e in #uantity

demanded

#uantity demanded is !reater than proportionate chan!e in

price

even if there is no chan!e in price

8/9/2019 Chapter 5 elasticity.ppt

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• 4eometrical 1/iagrammatic2) Datio of the two segments of the horizontal a(is identified by the intersection of the tangent to the point

considered, with the horizontal a(is and by the perpendicular from that point to the same a(is

• Lower segment of the tangent

Bpper segment of the tangent

ICE E!ASTICIT) *+ ,EA.,' *. A ,EA., C63E

ep 666666666666 66 5

8/9/2019 Chapter 5 elasticity.ppt

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P

Q $

A

C

B

ep 5 8 4 0; 5 8

ep 5 0. 4 ;. 5 ), . is the mid point of 0;

ep 5 0; 4 8 5 <

ep = )

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ICE E!ASTICIT) *+ ,EA.,' I. A !I.EA ,EA., C363E

>3 73

66 7E

2) 66

5 3)(

Elasticity o$ a !inear ,eand Cure

7he slope of a linear

demand

• Aontinuing our scenario, if you raise your price

from Ds.$ to Ds.&, would your reenue rise or fallK

Deenue = P ( Q

• * price increase has two effects on reenue) • igher P means more reenue on each unit

you sell.

• ut you sell fewer units 1lower Q2, due to Law of /emand.

• +hich of these two effects is biggerK

6t depends on the price elasticity of demand.

8/9/2019 Chapter 5 elasticity.ppt

• 6f demand is elastic, then

price elasticity of demand I #

% change in Q I % change in P

• 7he fall in reenue from lower Q is greater

than the increase in reenue from higher P ,

so reenue falls.

Deenue = P ( Q

'lastic demand 1elasticity = #.2 P

Q

D

Ds.$

+hen D is elastic,

Ds.&

• 6f demand is inelastic, then

price elasticity of demand H #

% change in Q H % change in P

• 7he fall in reenue from lower Q is smaller

than the increase in reenue from higher P ,

so reenue rises.

• 6n our e(ample, suppose that Q only falls to #$ 1instead

of 2 when you raise your price to Ds.&.

Deenue = P ( Q

rice Elasticity and Total eenue

Mow, demand is inelastic)

+hen D is inelastic,

lost

rice Elasticity and Total eenue

rice 3uan tity

& C $ -#. GG.J -9.J Delatiely 'lastic

C G C -. C$.$ -#. Delatiely 'lastic

9 C -.G .G -#.$ Bnitary 'lastic

#$ $ -C$.$ . -$.G Delatiely 6nelastic

# # # -GG.J #. -$.9 Delatiely 6nelastic

$ #C $ -$$.$ #&.C -$.# Delatiely

8/9/2019 Chapter 5 elasticity.ppt

+otal 2utlay or /evenue or Expenditure ethod

ICE E!ASTICIT) *+ ,EA.,' EAS6EE.T

ncrease in

+otal /evenue

(ecrease in

+otal /evenue

7o learn the determinants of price elasticity,

we look at a series of e(amples.

'ach compares two common goods.

6n each e(ample)

• 0uppose the prices of both goods rise by $%.

• 7he good for which Qd falls the most 1in percent2 has

the highest price elasticity of demand. +hich good is itK +hyK

• +hat lesson does the e(ample teach us about the

determinants of the price elasticity of demandK

8/9/2019 Chapter 5 elasticity.ppt

E9A!E :'

Thups-up s( Sugar • 7he prices of both of these goods rise by $%.

8or which good does Qd drop the mostK +hyK

• 7humps-up has lots of close substitutes

1e.g ., Aoca Aola, 0prite2, so buyers can easily switch if the price rises.

• 0ugar has no close substitutes,

so consumers would probably not buy much less if its price rises.

'esson Price elasticity is higher when close

substitutes are available .

E9A!E 2'

;1lue <eans= s( ;Clothing= • 7he prices of both goods rise by $%.

8or which good does Qd drop the mostK +hyK

• 8or a narrowly defined good such as

blue Neans, there are many substitutes

1khakis, shorts, 0peedos2.

defined goods.

1Aan you think of a substitute for clothing, other than liing in a nudist colonyK2

'esson Price elasticity is higher for narrowly

defined goods than broadly defined ones.

8/9/2019 Chapter 5 elasticity.ppt

E9A!E >'

• 7o millions of diabetics, insulin is a necessity.

* rise in its price would cause little or no decrease

in demand.

some people will forego it.

'esson Price elasticity is higher for luxuries than for

necessities. or necessities! it is inelastic.

E9A!E 4'

E9A!E 4'

asoline in the Short un s(

asoline in the !ong un • 7he price of gasoline rises $%. /oes Qd drop more in

the short run or the long runK +hyK

• 7here!s not much people can do in the

short run, other than ride the bus or carpool. • 6n the long run, people can buy smaller cars

or lie closer to where they work.

'esson Price elasticity is higher in the long run than the short run.

The ,eterinants o$ rice Elasticity'

8/9/2019 Chapter 5 elasticity.ppt

The ,eterinants o$ rice Elasticity'

A Suary

the e(tent to which close substitutes are aailable

whether the good is a necessity or a lu(ury

how broadly or narrowly the good is defined

the time horizon) elasticity is higher in the long

run than the short run.

7he price elasticity of demand depends on)

the e(tent to which close substitutes are aailable

whether the good is a necessity or a lu(ury

how broadly or narrowly the good is defined

the time horizon) elasticity is higher in the long

run than the short run.

8/9/2019 Chapter 5 elasticity.ppt

BCthe responsiveness of demand to a chan!e in

consumer income, D

t is computed as the percenta!e chan!e in the #uantity

demanded divided by the percenta!e chan!e in income" f we substitute variable Bincome for variable Bprice,

then the formula for measurin! income-elasticity of

demand is same as for measurin! price-elasticity of

demand

inferior !oods

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'(ample) C /O/s demanded [email protected] when consumer!s income 12 is Ds. $$$$. +hen income increased to Ds. &$$$, demand for

/O/ increases to 9$. Aalculate income elasticity of demand. 1use

mid-point method2

*nswer) ey = % Q in @d 5 % Q in

= 119$ -C2519$RC22 5 11&$$$ 3 $$$$2 5 1&$$$R$$$$22 = 1G 5 &C 2 5 1&$$$ 5 C&$$$2 = 1 #5E 2 5 1#5E2 = #

18ind what you are getting using percentage method2 Bnitary income elasticity of demand implying #% increase in

income of the consumer leads to # % increase in "uantity demanded of

/O/ /O/ in "uestion is a normal commodity since income elasticity of

demand is positie

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f demand function is !iven $3d is a function of ncome%

Aalculate income elasticity of demand at income leel 12 of Ds.

&$$$ if the demand function is @d = G$$ - $.$

*nswer) *t = &,$$$, "uantity demanded = G$$ - &$$ = #$$

ey =1 [email protected] 5 d2 F 1 5 @2

= 1-2$.$ F 1&$$$ 5 #$$2 = 1-2 & 6ncome elasticity of demand is elastic in nature implying #% increase

in income of the consumer leads to & % decrease in "uantity demanded

of the commodity 7he commodity in "uestion is an inferior commodity since income

elasticity of demand is negatie.

EASS6I. I.C*E E!ASTICIT) *+ ,EA.,

8/9/2019 Chapter 5 elasticity.ppt

@ature of .ommodities and ncome Elasticity of (emand

I.C*E E!ASTICIT) *+ ,EA.,

7oods ncome-elasticity Effect on sale

Essential or @ecessary !oods

.omforts or

unity ore than proportionate increase in sale

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BCthe responsiveness of demand of a commodity to a chan!e in the price of its related $substitutes and complementary% commodities

t is computed as the percenta!e chan!e in the #uantity demanded divided by the percenta!e chan!e in the price of substitute or complementary commodities"

ositive cross elasticity Aubstitutes

@e!ative cross elasticity .omplementary commodities

Fero cross elasticity ndependent commodities

+he !reater the absolute value of cross elasticity of demand, the more intense is the relationship existin! between the two !oods

C*SS E!ASTICIT) *+ ,EA.,

EAS6I. C*SS E!ASTICIT)

8/9/2019 Chapter 5 elasticity.ppt

EAS6I. C*SS E!ASTICIT) *+ ,EA.,

'(ample) units of Pizza is demanded [email protected] when the price of urger is Ds. $. +hen price of urger increases to Ds. &,

demand for Pizza increases to C. Aalculate cross elasticity of

demand using mid-point method.

*nswer) eP = % Q in @d of Pizza 5 % Q in Price of urger

= 11C -251CR22 5 11& 3 $2 5 1&R$22

= 1 5 G 2 5 1& 5 C&2 = 1 #59 2 5 1#5E2 = 9

Aross elasticity of demand is elastic in nature, implying #% increase in price of urger leads to 9 % increase in "uantity

demanded of Pizza. Pizza and urger in "uestion are substitute commodities since

cross elasticity of demand is positie.

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f demand function is !iven $3d is a function of rice of related commodity%

7he demand function for urger is estimated at

@ = G - $. P7, +here @ = @uantity demanded of urger and P7 is the

Price of 7omato Setchup.

Aalculate cross elasticity of demand at P7 = $. *nswer) *t P7 = $, @ = G - C =

e7 =1 d @ 5 d P72 F 1P7 5 @2

= 1-2$. F 1$ 5 2 = 1-2 Aross elasticity of demand is elastic in nature implying #% increase in Price

of 7omato Setchup leads to % decrease in "uantity demanded for urger urger and 7omato Setchup in "uestion are complementary to each other

since cross elasticity of demand is negatie.

EASS6I. C*SS E!ASTICIT) *+ ,EA.,

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7ime +atch Ao. assembles wrist watches and sells in +estern 6ndia. /emandfunction faced by the Aompany is estimated to be

@ = C$,$$$ 3 Pt 3 R CPc +here, @ = Mumber of watches demanded from 7ime +atch Ao. Pt = Price of watches sold by 7ime +atch Ao.

= Per-capita income in +estern 6ndia Pc = Price charged by Aasio +atch Ao, the competitors Aurrently Pt, 6 and Pc are Ds. 9&$, Ds.#$,$$$ and Ds. C$$ respectiely 'stimate a2Price elasticity of demandT

b26ncome elasticity of demand and comment on nature of productT

c2Aross elasticity of demand and bring how these two watches relates to each other. d2/o you recommend an increase in price if 7imes +atch Ao. wanted to ma(imise sales reenue K Uustify

E!ASTICIT) *+ ,EA.,

Copyright © 2004 South-Western/Thoson !earning

@ = C$,$$$ 3 Pt 3 R CPc +hen Pt, and Pc are Ds. 9&$, Ds.#$,$$$ and Ds. C$$ respectiely, @ = C$,$$$ 3 J$$ 3 $,$$$ R #G$$ = $,E$$

a2 Price elasticity of demand = 1-2 F 19&$ 5 $E$$2 = - J 5 $E = - $.$99CE

b2 6ncome elasticity of demand = 1-2 F 1#$$$$5$E$$2 = - $.EG

Mature of product 3 since ei H $, 6nferior commodity

c2 Aross elasticity of demand = 1C2 F 1C$$5$E$$2 = $.$JGG

Mature of relationship 3 since ei I $, 0ubstitutes

d2es. 0ales can be ma(imised when VD = $ or e p = #.

0ince demand is inelastic, increase in price will increase sales reenue.

E!ASTICIT) *+ ,EA.,

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THE E!"TI#IT$ %& "UPP$

• Price elasticity of supply is a measure of how much the "uantity supplied of a good responds

to a change in the price of that good.

• Price elasticity of supply is the percentage change in "uantity supplied resulting from a

percent change in price.

8/9/2019 Chapter 5 elasticity.ppt

rice Elasticity o$ Supply

much Qs responds to a change in P .

Price elasticity of s'ly

Percenta*e chan*e in Q s

Percenta*e chan*e in P

Loosely speaking, it measures the price-sensitiity of

sellers! supply.

percentage changes.

Q 2

at a price Ds.#$. +hen

price increases to Ds. #&,

$ units is supplied. 8ind

Percenta*e chan*e in Q s

Percenta*e chan*e in P

[email protected]'

Q 2

@s = #$$ R P

*t P = #$, @s = #$, [email protected] 5 dP =

P

Q

S

d3s

es = F 1#$5#$2 = #5G

8/9/2019 Chapter 5 elasticity.ppt

The 3ariety o$ Supply Cures

• 'conomists classify supply cures according to their elasticity.

• 7he slope of the supply cure is closely related

to price elasticity of supply. • Dule of thumb)

7he flatter the cure, the bigger the elasticity.

7he steeper the cure, the smaller the elasticity. • 7he ne(t slides present the different

classifications, from least to most elastic.

8/9/2019 Chapter 5 elasticity.ppt

S

P

S

;Inelastic=

P

S

S

;Elastic=

P

S

P

Q

P :

Q :

The ,eterinants o$ Supply Elasticity

• 7he more easily sellers can change the "uantity they produce, the greater the price elasticity of

supply.

• '(ample) 0upply of beachfront property is harder to ary and thus less elastic than

supply of new cars.

• 8or many goods, price elasticity of supply isgreater in the long run than in the short run,

because firms can build new factories, or

new firms may be able to enter the market.

8/9/2019 Chapter 5 elasticity.ppt

A!ICATI*. o$ E!ASTICIT)

• Aan good news for farming be bad news for farmersK

• +hat happens to wheat farmers and the market

for wheat when uniersity agronomists discoer a new wheat hybrid that is more productie

than e(isting arietiesK

8/9/2019 Chapter 5 elasticity.ppt

TE A!ICATI*. *+ S6!)" ,EA.," A., E!ASTICIT)

• '(amine whether the supply or demand cure shifts.

• /etermine the direction of the shift of the

cure. • Bse the supply-and-demand diagram to see

how the market e"uilibrium changes.

An Increase in Supply in the ar#et $or Wheat

8/9/2019 Chapter 5 elasticity.ppt

Duantity o$

increase in 7'antity sold2 !s a res'lt8

reven'e falls from 96-- to 9::-2

Demand

an increase in s'ly 2 2 2

:

"'mmary

• Price elasticity of demand measures how much the "uantity demanded responds to changes in

the price.

• Price elasticity of demand is calculated as the percentage change in "uantity demanded

diided by the percentage change in price.

• 6f a demand cure is elastic, total reenue falls when the price rises.

• 6f it is inelastic, total reenue rises as the price

rises.

"'mmary

• 7he income elasticity of demand measures how much the "uantity demanded responds to

changes in consumers! income.

• 7he cross-price elasticity of demand measures how much the "uantity demanded of one good

responds to the price of another good.

• 7he price elasticity of supply measures how much the "uantity supplied responds to changes

in the price. .

"'mmary

• 6n most markets, supply is more elastic in the long run than in the short run.

• 7he price elasticity of supply is calculated as

the percentage change in "uantity supplied diided by the percentage change in price.

• 7he tools of supply and demand can be applied

in many different types of markets.