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ELASTICITYELASTICITY
RESPONSIVENESSRESPONSIVENESS
measures the responsivenessof the quantity demanded of
a good or service to a change in its price.
Price Elasticityof Demand
Price Elasticity of demand is calculated by dividing the percentage change in quantity by the percentage change in price.
% QD
% PEp =
Use this method if both the price and the quantity data is given as percentages
Mid - point methodMid - point method
Ep = Ep = ∆Q∆Q x ( x (p1 + p2)/2p1 + p2)/2
∆ ∆P (q1 + q2)/2 P (q1 + q2)/2
Use this method if we have two set of points
What does the co-efficient What does the co-efficient mean?mean?
Co-efficientCo-efficient Type of Type of elasticityelasticity
0 - 10 - 1 InelasticInelastic
11 UnitaryUnitary
> 1> 1 ElasticElastic
TOTAL REVENUE METHODTOTAL REVENUE METHODTOTAL REVENUE METHODTOTAL REVENUE METHOD
• IF PRICE AND IF PRICE AND TOTAL REVENUE TOTAL REVENUE MOVE IN THE MOVE IN THE SAME DIRECTION SAME DIRECTION THENTHEN
• IF PRICE AND IF PRICE AND TOTAL REVENUE TOTAL REVENUE MOVE IN MOVE IN OPPOSITE OPPOSITE DIRECTIONS THENDIRECTIONS THEN
INELASTICDEMAND ELASTIC
DEMAND
P
$
4
2
0 6 7 Q
D
Ep = 1 * 3
2 6.5
= 0.23
= inelastic
EXAMPLE ONEEXAMPLE ONE
Total revenue methodTotal revenue method
P
$
4
2
0 6 7 Q
DAn increase in price ($2-$4) causes an increase in total revenue ($14-$24).
A decrease in price ($4-$2) causes a decrease in total revenue ($24-$14)
D
P
$
4
2
0 2 4 Q
Ep = 2 * 3
2 3
= 1
= unitary
EXAMPLE TWOEXAMPLE TWO
Total revenue methodTotal revenue method
D
P
$
4
2
0 2 4 Q
An increase or decrease in price will have no affect on total revenue.
$4 x 2 = $8 $2 x 4 = $8
P
$
4
3
0 4 6
D
Ep = 2 * 3.5
1 5
= 1.4
= elastic
EXAMPLE THREEEXAMPLE THREE
Q
Total revenue methodTotal revenue method
An increase in price brings about a An increase in price brings about a decrease in total revenue (P*Q).decrease in total revenue (P*Q).($18 - $16)($18 - $16)
A decrease in price brings about an A decrease in price brings about an increase in TR increase in TR
(from $16 - $18)(from $16 - $18)
P
$
4
3
0 4 6
D
Q
SPECIAL CASESSPECIAL CASESSPECIAL CASESSPECIAL CASES
P P
D
D
PERFECTLY INELASTIC.
A change in price brings about no response - no change in quantity demand.
PERFECTLY ELASTIC
A change in price brings about an infinite response in quantity demand.
Ed=0
Ed=
Elasticities, Elasticities, Price Price Changes and Changes and Total Total RevenueRevenue
What What determines determines elasticity for a elasticity for a product?product?
1. Whether or not it has close substitutes.
No close substitutes = inelastic
Close substitutes = elastic
2. Is it a necessity or a luxury?
Necessity = inelastic
Luxury = elastic
3.Is it a small or large proportion of income?
Small proportion = inelastic
Large proportion - elastic
4. Is it durable or not
Durable = more elastic. Consumption can be postponed until price falls
Non - durable = more inelastic. It is used up quickly so consumption can not be postponed.
5. Is it addictive?
Addictive goods will have inelastic demand as some consumers can not do without them.
Elasticity along the Demand Elasticity along the Demand CurveCurve
D
$
Q25
50
20
80
10 40
Point of Unitary Elasticity
Elastic Region
Inelastic Region
Income elasticity of demand
measures the responsiveness
of the quantity demanded of a good or service to a
change in income.
Income Elasticity of demand is calculated by dividing the percentage change in quantity by the percentage change in income.
% QD
% YEy =
What does the co- efficient mean?
Co-efficientCo-efficient MeaningMeaning
NegativeNegative Inferior goodsInferior goods
0- 10- 1 Normal good - Normal good - necessitynecessity
> 1> 1 Normal good - Normal good - luxuryluxury
Inferior Goods
Have a negative income elasticity because when income increases, less of the good will be purchased.
Necessities
Have a income elasticity of between 0 and 1. This is an inelastic response, the percentage increase in amount purchased is less than the percentage increase in income.
Luxuries
Have an income elasticity of greater than 1. This is an elastic response as the percentage change in amount purchased is greater than the percentage change in income.
Cross-price elasticity of demand.
measures the responsivenessof the quantity demanded of
one good to changes in price of another good.
Cross-price elasticity of demand is calculated by dividing the percentage change in quantity of one good by the
percentage change in price of the other good.
% Qx
% PyEcross =
Complements.
These are goods that are used together. They will have a negative cross
elasticity.
Substitutes
These are goods that are used in place of each other.
They will have a positive cross elasticity.
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