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Lifetime Learning… Building Success… Towards Globalization
Economics -Chapter 3Elasticity
Lifetime Learning… Building Success… Towards Globalization
The Price Elasticity of Demand
• What is price elasticity of demand?
• The price elasticity of demand (PED) measures how much thequantity demanded of a good changes when its price changes.
• PED measures the responsiveness of the quantity demanded(QD) of a product to a change in its own price.
EIBFS/Economics
• Formula for calculating PED.
• PED = “percentage change in quantity demanded
percentage change in price.
• Can be rewritten as:Ed = ∆Q x P
∆P x Q
– Q: the original Quantity
– P: the original Price
– ∆Q: the change in quantity (New Quantity – Old Quantity)
– ∆P: the change in price( New Price – Old Price)
EIBFS/Economics
Example
• Price increase from 10p to 20p
• Quantity demanded falls from10m to 8m per week.
• PED = Δq x pΔ p q
• q = 10 p = 10
• Δq = - 2 Δp = 10
Ed = -2 x 10 = - 0.2
• 10 10
• Ignore the negative sign.
• The absolute value is less than one; Inelastic demand
EIBFS/Economics
Example
• Price increase from 30p to 40p
• Quantity demanded falls from6m to 4m per week.
• PED = Δq x pΔ p q
• q = 6 p = 30
• Δq = - 2 Δp = 10
Ed = -2 x 30 = 1
• 10 6
• The absolute value is one; Unity or unit elastic demand
EIBFS/Economics
Example
• Price increase from 40p to 50p
• Quantity demanded falls from4m to 2m per week.
• PED = Δq x pΔ p q
• q = 4 p = 40
• Δq = - 2 Δp = 10
Ed = -2 x 40 = 2
• 10 4
• The absolute value is more than one;
• Elastic demand
EIBFS/Economics
Measuring PED
• On a straight line demand curve the price elasticity of demandincreases as the price rises and the quantity demanded falls.
• Demand curve is more elastic as we move up the demandcurve from right to left.
• The reason for the negative sign is because of the negativeslope of the normal demand curve, therefore we ignore it.
EIBFS/Economics
7
Types of Price Elasticity of Demand
Inelastic Demand
Elastic Demand
Unit Elastic Demand
Perfectly inelastic demand
Perfectly elastic demand
EIBFS/Economics
8
Types of Price Elasticity of Demand
• Inelastic Demand: when the percentage change in quantitydemanded is less than the percentage change in its price.
• Elastic Demand: when the percentage change in quantitydemanded is greater than the percentage change in its price.
• Unit Elastic Demand: when the percentage change in quantitydemanded and percentage change price are equal.
• Perfectly inelastic demand: Whatever the % change in priceno change in quantity demanded.
• Perfectly elastic demand: An infinitely small % change in priceleads to infinitely large % change quantity demanded.
EIBFS/Economics
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• Inelastic Demand: % change in demand is less than one
• Elastic Demand: % change in demand is more than one
• Unit Elastic Demand: % change in demand is equal to one.
• Perfectly inelastic demand: Zero elastic, No change indemand due to change in price
• Perfectly elastic demand: infinity An small % change in priceleads to infinitely % change in demand.
EIBFS/Economics
Varying Elasticity Curve __ Straight Line Demand Curve
•PED, usually varies along the length of demand curve on a straight line demand curve.
• Above the mid point the PED isgreater than 1; Elastic.
• Below the mid point PED isless than 1; Inelastic
• At the mid point PED is equalto 1; Unity
EIBFS/Economics
Exceptions Constant Elasticity Curves
12
Perfectly inelastic Perfectly elastic Unity elastic
•A Vertical Demand Curve has a constant elasticity of zero(Perfectly Inelastic)•A Horizontal Demand Curve has a constant elasticity of infinity ( PerfectlyElastic)•A Rectangular hyperbola Curve has a constant elasticity of one ( Unit elastic)
Varying Elasticity
Straight Line Demand Curve
• Above the mid point:
• PED; Greater than 1; Elastic
• Below the mid point:
• PED; Less than 1; Inelastic
• Mid point;• PED; Equal to 1; Unity
Constant Elasticity Demand Curves
• Vertical Demand Curve
– Perfectly Inelastic=0
• Horizontal Demand Curve
– Perfectly Elastic= infinity
• Rectangular hyperbola Curve
– Unit Elastic = 1
EIBFS/Economics 13
Price elasticity of demand and Total Revenue
• Price elasticity of demand is important in relation toits effect on total revenue.
• Total revenue (TR) is total amount obtained from the sale ofa product.
Total Revenue = Price x Quantity sold
TR = P x q
where, P is price and q is quantity.
EIBFS/Economics
Elasticity and Total Revenue
• Demand is Elastic→ PED >I
– Fall in price: Total revenue rises
– Rise in price: Total revenue falls
• Demand is Inelastic → PED < I
– Rise in price: Total revenue rises
– Fall in price: Total revenue falls
• Demand is Unit elastic → PED = I
– No change in Total Revenue
* (ignoring sign)
EIBFS/Economics
15
16
Relationship between Price elasticity of demand and Total Revenue
Elasticity of Demand Price Total Revenue
Elastic >1 Fall
Rise
Rise
Fall
Unity PED=1 Fall
Rise
No change
No change
Inelastic <1 Fall
Rise
Fall
Rise
Factors Determining Price Elasticity of Demand
Two main important factors that determine the value ofPED are:
a) Availability of close substitutes: The closer the substitutefor a good, the more elastic the demand. ( the consumershall switch to closer substitute)
b) Time period. The longer the time available the more elasticthe demand as consumers take time to adjust theirpurchasing habits.
EIBFS/Economics