Elasticity of demand 1

Elasticity of demand 1

Elasticity of demand What elasticity measures? How the price elasticity formula is applied to measure the elasticity of demand? The difference between elastic, inelastic and unitary elastic demand? How total revenue varies in each of these tree cases? The meaning of perfect elasticity and perfect inellasticity 2

Price elasticity of demand is a measure of the sensitivity of quantity demanded to chages in the price of a product When quantity demanded is relatively sensitive (insensitive) to a price change demand is said to be elastic (inelastic) 3

Degree of elasticity 4 The exact degree of elasticity can be measured by using a formula to compute the elasticity coefficient: E C D P where: D percentage change in demand: (y t -y t-1 )/y t-1 P percentage change in prices: (x t -x t-1 )/x t-1

How to estimate price elasticity 5 P - price D - demand P D Ep 2,5 80 5 60 100% -25% -0,25 7,5 40 50% -33% -0,67 10 20 33% -50% -1,50 It is important to note that the elasticity of demand is not the same at all prices and that demand is typically elastic at higher and inelastic at lower prices

Elastic, inelastic and unit elastic demand 6 Demand is elastic (inelastic, unit elastic) when the percentage change in quantity is greater then (less then, equal to) the percentage change in price and the elasticity coefficient is greater than (less than, equal to) 1

Types of price elasticity of demand Elasticity Description Behavior E p = 0 Perfectly inelastic demand changes in the price do not affect the quantity demanded for the good 7-1 < E p < 0 Inelastic or relatively inelastic demand percentage change in quantity demanded is smaller than that in price E p = - 1 Unit elastic, unit elasticity, unitary elasticity, or unitarily elastic demand percentage change in quantity is equal to that in price - < E p < - 1 Elastic or relatively elastic demand percentage change in quantity demanded is greater than that in price E p = - Perfectly elastic demand any increase in the price, no matter how small, will cause demand for the good to drop to zero

Necessity good Is type of normal good. Like any other normal good, when income rises, demand increases. But the increase for a necessity good is less than proportional to the rise in income, so the proportion of expenditure on these goods falls as income rises (this observation for food is known as Engel's law) Necessity goods are goods that we can't live without and won't likely cut back on even when times are tough, for example food, power, water and gas (most necessity goods are usually produced by a public utility) 8 The income elasticity of a necessity good is thus between zero and one. The more necessary a good is, the lower the price elasticity of demand, as people will attempt to buy it no matter the price.

The sign of elasticity coeficient Because price and quantity demanded are inversely related to each other the price elasticity of demand coefficient is a negative number but economists ignore the minus sign in front of the coefficient and focus their attention on its absolute value 9

The price elasticity of demand for a product depends upon 10 the number of good subsitutes the product has its relative importance in the consumer s budget whether it is a necessity or luxury

Relation between price elasticity and revenue 11 The way in which total revenue changes (increases, decreases, or remains constant) when price changes is a test of the elasticity of demand for a product For elastic demand E p (- ;-1): when price decreases (increases) then revenues increases (decreases) For inelastic demand E p (- 1 ; 0): when price decreases (increases) then revenues decreases (increases) For unit elastic demand E p =-1: the revenues are maximum

Perfectly inelastic demand: E c =0 12 changes in the price do not affect the quantity demanded for the good; raising prices will cause total revenue to increase

(relatively) inelastic demand:-1<e c <0 13 percentage change in quantity demanded is smaller than that in price when the price is raised, the total revenue rises, and vice

Unit (unitary) elastic demand: E c =-1 14 percentage change in quantity is equal to that in price, a change in price will not affect total revenue

(relatively) elastic demand: - <E c <-1 15 percentage change in quantity demanded is greater than that in price when the price is raised, the total revenue falls, and vice versa

Perfectly elastic demand: E c = - 16 any increase in the price, no matter how small, will cause demand for the good to drop to zero when the price is raised, the total revenue falls to zero

The example of the previous rule 17 P price in D-demand in tho.of units P D E p Revenues in tho. of 2,50 80-100% 25% -0,25 200 5,00 60-10% 7% -0,67 300 5,50 56-9% 7% -0,79 308 6,00 52-4% 4% -0,92 312 6,25 50-12% 12% -1,00 312,5 7,00 44-7% 9% -1,27 308 7,50 40-33% 50% -1,50 300 10,00 20

Fill-in questions 1 18 To find out that the demand is elastic you must know (price elasticity of demand, income elasticity of demand)...

Fill-in questions 2 If a relatively large change in price results in a relatively small change in demand, demand is (elastic/ineclastic/perfect eleasit). If a relatively small change in price results in a relatively large change in demand, demand is (elastic/ineclastic/perfect eleastic).. 19

Fill-in questions 3 If a change in price causes no change in demand, demand is perfectly (elastic, inelastic)...and the demand curve is (perpendicular to any axis, slopes down in the rights) If an extremely small change in price results in an extremely large change in demand, demand is (perfectly elastic/perfectly inelastic) 20

Fill-in questions 4 21 If the price of a commodity declines when demand is inelastic the loss of revenue due to the lower price is (greater than, less then, equal to).the gain in revenue due to the greater quantity demanded when demand is elastic the loss of revenue due to the lower price is (greater than, less then, equal to).the gain in revenue due to the greater quantity demanded when demand is inelastic the loss of revenue due to the lower price is (greater than, less then, equal to).the gain in revenue due to the greater quantity demanded

Fill-in questions 5 22 If demand is elastic, price and total revenue are (directly, inversely). related If demand is inelastic, price and total revenue are (directly, inversely). related

Fill-in questions 6 23 Complete the summary table below If demand is: The elasticity coefficient is If price rises, total revenue will If price falls, total revenue will Elastic Inelastic Of unitary elasticity

Fill-in questions 6 Which of below determinants are not the determinants of the elasticity of demand: 1. The number of good substitute products 2. The relative importance of the product in the total budged of the buyer 3. Whether the good is a necessity or a luxury 24

Fill-in questions 7 25 If the demand schedules for a certain product are those given in the table, answer the following questions. Price in $ Demand in units 10 12 9 13 8 14 7 15 6 16 5 17 4 18 What is price elasticity of demand for price P=6$... If we reduct price to 5$, revenus will (decrease/increase) What is the best price for this product..