# 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
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 =
#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
start alue ( #\$\$%
1&3\$25\$ = &%
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. = #.
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
• 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
P
Q \$
A

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 = )
8/9/2019 Chapter 5 elasticity.ppt
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
'(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
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
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
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.,
8/9/2019 Chapter 5 elasticity.ppt
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.,
@ = 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.,
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 =

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

;Inelastic=

;Elastic=

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.