elasticities price elasticity of demand income elasticity of demand cross elasticity of demand

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Elasticities Price Elasticity of Demand Income Elasticity of Demand Cross Elasticity of Demand

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Page 1: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Elasticities

Price Elasticity of DemandIncome Elasticity of DemandCross Elasticity of Demand

Page 2: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Real world applications of Elasticity…

The economic concept of “Elasticity” is usedprimarily by producers to predict changes inconsumer demand.By how much will demand change if……- The price of a good increases/decreases- Consumer incomes increase/decreaseHow do I know if a good is a

compliment/substitute………..

Page 3: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

A.S 3.2 Response of the Market to change….

“The description of how a market responds to change will involve aselection from:

Elasticity definitions of price elasticity of demand, cross elasticity of demand,income elasticity of demand and price elasticity of supply calculation of price elasticity of demand, cross elasticity of demand,income elasticity of demand and price elasticity of supply reasons for differing elasticities for different goods and services significance for firms in their pricing decisions supply responsiveness in the long term compared with the short term.”

Page 4: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Price Elasticity of Demand

Textbook pp. 48-55- Read & then make notes on the followingObjectives: 1. Define Price Elasticity of Demand2. Calculate Price Elasticity- Percentage Change Method & Mid Point Method3. Impact on Revenue* Calculation can be used to calculate

elasticity & the relative elasticity of a good will determine the impact on Revenue

4. Describe the different elasticities of demand5. Explain the factors that affect elasticity of demand

Page 5: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Price Elasticity of demand

“Measures the responsiveness of the quantity demanded of a good or service to its change in

price”

In other words if the price is increased or decreased how

much quantity demanded will change, if at all.

Page 6: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Calculations for Price Elasticity of Demand

Coefficient = a pure number used to quantifyElasticity

Depending on the information given there are 3methods used to calculate elasticity:- Percentage Change (Arc)- Mid Point- Change in Revenue

Page 7: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Percentage Change

Ep = % QD % P

Page 8: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Mid- Point Method

Ep = Q Q1 +Q2

2 P

P1 +P2 2

Ed = 0 < 1 InelasticEd => 1 Elastic

Ed = 0 = 1 Unitary

Page 9: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Revenue Change

Total Revenue 1 – Total Revenue 2Price ↓ Revenue ↑ Price ↑ Revenue ↓Price ↓ Revenue ↓Price ↑ Revenue ↑

Elastic

Inelastic

Page 10: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Demand Curves

What does the shape of the curve tell you?

H.E.V.I

Page 11: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

So what does this mean?

• What kind of goods or services would have elastic demand?

• What kind of goods would have inelastic demand?

Page 12: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Elastic Demand

Goods & services

likely to be elastic...

Are Luxuries

Can be easily

postponed

Involve a relatively

high proportion of income

Have many close

substitutes

Page 13: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Inelastic Demand

Goods & services

likely to be inelastic...

Are Necessities

Can not be easily

postponed

Involve a relatively

low proportion of income

Have few close

substitutes

Page 14: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Elasticity in application

In class do activities 4.4 & 4.5 in your text book.

For homework do Questions: 3, 4, 7 & 8 in your workbook.

Page 15: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Income Elasticity of Demand & Cross Elasticity of Demand

Read pages 58-61 & then make notes which achieve the followingaims/objectives:

Define Income & Cross-Elasticity of Demand Calculate Income & Cross-Elasticity of Demand * Describe how the relative elasticity indicates if a good is Substitute or a Complement Normal Good, Luxury, Basic Necessity or an Inferior Good

* The text only has one (% ) but the mid point formula also applies

Page 16: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Cross Elasticity of Demand

“Cross-Elasticity of Demand measures by how much the quantity demanded of one product

will increase or decrease after a change in price of another good.”

Put simply it shows if there is a relationshipbetween goods and or services. Specifically whether they are complements orsubstitutes.

Page 17: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Calculations for Cross-Elasticity

Either

EC = % QB

% PA

Or

EC = QB

QB1 +QB2 2

PA

PA1 +PA2 2

Percentage Change

Mid Point Method

Page 18: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Implications….

A positive coefficient suggests a Substitute good or service

A perfect substitute will have a very high co-efficient

If the coefficient is 0 then there is no relationship

A negative coefficient suggests a complementary good.

Page 19: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Complements & Substitutes

Substitutes can be recognised by having a positive coefficientmeaning that an increase in the price of one good will result inan increase in demand for the other

Complements are recognised by having a negative coefficient,meaning that an increase in the price of one good will cause adecrease in demand for the other.

Important “Sheer coincidence” Sometimes there is no relationship

between 2 very obviously random & unconnected goods.

Page 20: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Aggregate Household Spending

Back in year 11 you looked at the overall patterns of householdexpenditure. Specifically identifying the pattern of consumptionOn Necessities, Luxuries, Savings, Inferior v Normal Goods.

Because Consumers are all different their tastes & preferencesand specifically spending patterns will differ. Sometimes it is notobvious or clear that a good or service is a luxury or a necessity.

The Economic Concept of Elasticity helps to identifypatterns between income & demand for specifictypes of goods & services

Page 21: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Calculations for Income Elasticity of Demand

Either

Ey = % QD % Y

Or

Ey = Q

Q1 +Q2 2

Y Y1 +Y2

2

Sound Familiar? The mid

point formula is basically

The same for all elasticity

calculations. Quantity

Will always sta

y on top

Page 22: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Implications…

A positive coefficient suggests a Normal Good

A very high coefficient suggests a luxury good

A coefficient which is less than one suggests a

good is a necessity

A negative coefficient suggests an inferior good,

sometimes known as a Giffen Good.

Page 23: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Types of Goods & Services…. Normal. Goods or services that are slightly better quality.Demand for normal goods will increase as income increases. LuxuryGoods or services that are “treats, obtained via discretionaryincome. Demand will increase with an increase income NecessityBasic goods or services that vital or needed for survival. Inferior (Griffin Goods)Low quality, budget brand goods. When income increases,demand will decrease

Page 24: Elasticities  Price Elasticity of Demand  Income Elasticity of Demand  Cross Elasticity of Demand

Applying it….

Do activity 4.6 on p. 57/58 (Good real worldexample ;-)

Then also add to homework/do workbookquestionsIncome Elasticity – p. 26 Q. 12,13 & 15Cross Elasticity – p. 28 Q. 19, 20For fun …. Multiple Choice p. 29/30