elasticity 32 of 32 demand 1

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Elasticity of Demand

Demand Determinants


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Definition of Elasticity of demand

Responsiveness of demand to changes in

any of the variables that determine demand.

Price Elasticity of demand:

Income Elasticity:

Cross Price Elasticity:

= qp

pqep

=q

I

I

qeI

=q

p

p

qe

r

r

pr


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The Price Elasticity of Demand


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At a price of $20 per barrel,the world quantity of oildemanded is 10 millionbarrels per day (point A).

When price rises to $21 perbarrel, world demand falls to9.9 million barrels per day(point B).


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Calculating the price elasticity of demand for oil


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Using the Midpoint Method to CalculateElasticities

The is a technique forcalculating the percent change. In thisapproach, we calculate changes in a

variable compared with the average, ormidpoint, of the starting and final values.


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Using the Midpoint Method to CalculateElasticities numerical example

= %20

= %20

= 1


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Some Estimated Price Elasticities of Demand

Eggs 0.1 Beef 0.4 Stationery 0.5 Gasoline 0.5

Housing 1.2 Restaurant meals 2.3 Airline travel 2.4

Foreign travel 4.1

Price elasticity ofdemand < 1

Price elasticity ofdemand > 1


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Interpreting the Price Elasticity of Demand: HowElastic Is Elastic?

Two Extreme Cases of Price Elasticity of Demand

Demand is when the quantitydemanded does not respond at all to the price. When

demand is perfectly inelastic, the demand curve is avertical line.

Demand is when any price

increase will cause the quantity demanded to drop tozero. When demand is perfectly elastic, the demandcurve is a horizontal line.


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Interpreting the Price Elasticity of Demand: HowElastic Is Elastic?

Unit-Elastic Demand, Inelastic Demand, and Elastic

Demand

Demand is if the price elasticity of demand

is greater than 1, if the price elasticity ofdemand is less than 1, and if the priceelasticity of demand is exactly 1.


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Highway departmentcharges for crossing a

bridge


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Why does it matter whether demand is unit-elastic, inelastic, or elastic?

Because this classification predicts how changesin the price of a good will affect the total revenueearned by producers from the sale of that good.

The is defined as the total valueof sales of a good, i.e.

Total revenue = Price quantity sold


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Elasticity and Total Revenue

When a seller raises the price of a good, there aretwo countervailing effects in action (except in the rarecase of a good with perfectly elastic or perfectlyinelastic demand):

After a price increase, eachunit sold sells at a higher price, which tends to raise

revenue. After a price increase, fewer

units are sold, which tends to lower revenue.


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Relationship of Price Elasticity with

Total Revenue

When price decreases, following the lawof demand the quantity sold rises.

TR will fall, when demand curve is

inelastic in nature, i.e. price effect stronger TR will rise, when demand curve is elastic

in nature, i.e. sales effect stronger

TR will remain constant, when demandcurve is unit-elastic, i.e both the effectsoffset each other


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What Factors Determine the Price Elasticity ofDemand?


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Income Elasticity of demand

The income elasticity of demand is the percentchange in the quantity of a good demanded

when a consumers income changes dividedby the percent change in the consumersincome.

eI= % change in demand

% change in income


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Nature of goods according to

Income elasticity

eI >0 => Normal Goods

eI < 0 => Inferior Goods

eI Necessities

eI >1 => Luxury Goods


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Cross Price Elasticity

ePR= % change in demand

% change in Price of RP

The between twogoods measures the effect of the change in one goodsprice on the quantity demanded of the other good. It isequal to the percent change in the quantity demanded of

one good divided by the percent change in the othergoods price.


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Cross-Price Elasticity

Goods are when the cross-priceelasticity of demandis positive.

Goods are when the cross-priceelasticity of demand is negative.


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Measuring the Price Elasticity of Supply

The is a measure ofthe responsiveness of the quantity of a goodsupplied to the price of that good. It is the ratio ofthe percent change in the quantity supplied to the

percent change in the price as we move along thesupply curve.


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What Factors Determine the Price Elasticityof Supply?

The priceelasticity of supply tends to be large when inputsare easily available. It tends to be small when

inputs are difficult to obtain. The price elasticity of supply tends tobecome larger as producers have more time torespond to a price change. This means that the

long-run price elasticity of supply is often higherthan the short-run elasticity.


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Economics in Action:

Imposition of a price floorsto support the incomes of farmershas created butter mountains and wine lakes in Europe.

Were European politicians unaware that their price floors wouldcreate huge surpluses?

They probably knew that surpluses would arise, butunderestimated the price elasticity of agricultural supplydue toavailability of inputs.

They thought big increases in production were unlikely sincethere was little new land available in Europe for cultivation.

However, farm production could expand by adding other resources,especially fertilizer and pesticides. So although farm acreage didntincrease much, farm production did!


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Elasticity and the Incidence of Excise Tax

When the price elasticity of demand is higherthan the price elasticity of supply, an excise taxfalls mainly on the producers.

When the price elasticity of supply is higher thanthe price elasticity of demand, an excise tax fallsmainly on consumers. So elasticitynot wholiterally pays the taxdetermines the incidence ofan excise tax.


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elasticity 32 of 32 demand 1

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