150618_UWIN-PIE04-s57

Bachelor in Economics (S.E): Manajemen

Course : Pengantar Ilmu Ekonomi (1506PIE04)

online.uwin.ac.id

Session Topic : Elasticity & Its Application

Course: Pengantar Ilmu Ekonomi

By Tovan Krisdianto, S.E., M.M.

UWIN eLearning Program

Powered by HarukaEdu.com - 1506PIE04- S.3

Content

Part 1 Elasticity of Demand

Part 2 Ranges of Elasticity

Part 3 Elasticity of Supply

Part 4 Summary

Part1: Elasticity of Demand


Elasticity: Definition & Price

Elasticity

Defn:

A measure of how much buyers & sellers respond to changes in market conditions.

Allows us to analyze supply & demand with greater precision.

Price elasticity of demand

Defn: Percentage change in quantity demanded given a percent change in the price.

It is a measure of how much the quantity demanded of a good responds to a change in the price of that good.


Elasticity: Determinants

Determinants of Price Elasticity of Demand

1. Availability of Close Substitutes

2. Necessities versus Luxuries

3. Definition of the Market

4. Time Horizon

Demand tends to be more elastic:

a. If the good is a luxury.

b. The longer the time period.

c. The larger the number of close substitutes.

d. The more narrowly defined the market.


Elasticity: Computing the Price Elasticity of Demand

The price elasticity of demand

Defn: Computed as the percentage change in the quantity demanded divided

by the percentage change in price.

Price Elasticity of Demand =Percentage Change in Quantity Demanded

Percentage Change in Price

Example:

If the price of an ice cream cone increases from $2.00 to $2.20 & the amount you buy falls from 10 to 8 cones then your elasticity of demand

would be calculated as:

100%

100%

20 percent

10 percent= 2=

(108)

10

(2.20 2.00)

2.00


Elasticity: Computing the Price Elasticity of Demand (Cont.)



Example:

Point A: PRICE =$4 Quantity = 120 Point B: PRICE =$6 Quantity = 80

A to B B to A

(12080)

120

(6.004.00)

4.00

100%

100%

33 %

50 %= 0.66=

(80120)

80

(4.006.00)

6.00

100%

100%

-50 %

-33 %= 1.5=


Elasticity: Computing the Price Elasticity of Demand Using the Midpoint Formula

The midpoint formula

Defn:

Preferable when calculating the price elasticity of demand because

it gives the same answer regardless of the direction of the change.

Price Elasticity of Demand =(Q2 Q1)/[(Q2 +Q1)/2]

(P2 P1)/[(P2 +P1)/2]





Example:

Point A: PRICE =$4 Quantity = 120 Point B: PRICE =$6 Quantity = 80

(80120)

A to B B to A

= -2=

(6.00+4.00)/2

(80+120)/2

(6.004.00)

- 40%

20%

(12080)

= -2=

(4.00+6.00)/2

(120+80)/2

(4.006.00)

40

- 20%



Demand is price elastic

4 Demand

Quantity1200

Price

$6

80

40 percent

-20 percent= -2=

(120-80)

(120+80)/2

(4.00-6.00)

(4.00+6.00)/2

ED =

Part2: Ranges of Elasticity


Ranges of Elasticity: The Variety of Demand Curves

a. Inelastic Demand

Quantity demanded does not respond strongly to price changes. Price elasticity of demand is less than one.

b. Elastic Demand

Quantity demanded responds strongly to changes in price. Price elasticity of demand is greater than one.

c. Perfectly Inelastic

Quantity demanded does not respond to price changes.

d. Perfectly Elastic

Quantity demanded changes infinitely with any change in price.

e. Unit Elastic

Quantity demanded changes by the same percentage as the price.


Ranges of Elasticity: Perfectly Inelastic Demand-Elasticity Equals 0

100

Demand

Quantity

2. ...leaves the quantity demanded unchanged

Price

1. An $5increase

in price... 4


Ranges of Elasticity: Inelastic Demand-Elasticity is Less than 1

Quantity

Price

1. A 22% $5

increase

in price... 4

Demand

90 1002. ...leads to a 11% decrease in quantity


Ranges of Elasticity: Unit Elastic Demand-Elasticity Equals 1

Price

1. A 22% $5

increase

in price... 4

Demand

Quantity80 1002. ...leads to a 22% decrease in quantity


Ranges of Elasticity: Elastic Demand-Elasticity is Greater than 1

Price

1. A 22% $5

increase

in price... 4

Demand



Ranges of Elasticity: Perfectly Elastic Demand-Elasticity Equals Infinity

Demand

Quantity

Price

$4

2. At exactly $4,consumers willbuy any quantity.

3. At a price below $4,quantity demanded is infinite.

1. At any price

above $4, quantitydemanded is zero.


Ranges of Elasticity: Elasticity & Total Revenue

Total revenue

Defn: The amount paid by buyers & received by sellers of a good. Computed as the price of the good times the quantity sold.

TR = P x Q

Figure

Demand

Quantity

$4

P

0

Price

100

P x Q = $400

(total revenue)

Q


Ranges of Elasticity: Elasticity & Total Revenue along a Linear Demand Curve

With an inelastic demand curve,

an increase in price leads to a decrease in quantity that is proportionately smaller.

Thus, total revenue increases.

$3

Quantity0

Price

80

Revenue = $240

Demand$1 Demand

Quantity0

Revenue = $100

100

Price

An increase in price

from $1 to $3...

leads to an increase

in total revenue

from$100 to $240


Ranges of Elasticity: Elasticity & Total Revenue along a Linear Demand Curve (Cont.)

With an elastic demand curve,

an increase in the price leads to a decrease in quantity demanded that is proportionately larger.

Thus, total revenue decreases.

Quantity0

Price

$4

50

Demand

Quantity0

Price

Revenue = $100

$5

20

leads to a decreasein total revenue

from$200 to $100

Revenue = $200


from $4 to $5...

Demand


Ranges of Elasticity: Computing the Elasticity a Linear Demand Curve (Cont.)

Price

(A)

Quantity

(B)

Total

Revenue

(A x B)

Percent

Change in

Price

Percent

Change in

Quantity

Elasticity Description

$0 14 $0 200% 15% 0.1 Inelastic

1 12 12 67 18 0.3 Inelastic

2 10 20 40 22 0.6 Inelastic

3 8 24 29 29 1 Unit Elastic

4 6 24 22 40 1.8 Elastic

5 4 20 18 67 3.7 Elastic

6 2 12 15 200 13 Elastic

7 0 0


Income Elasticity: Definition

Income Elasticity of Demand

Defn: Measures how much the quantity demanded of a good responds to a change in consumers income.

It is computed as the percentage change in the quantity demanded divided by the percentage change in income.

Computing Income Elasticity

Income Elasticity of Demand =Percentage Change in Quantity Demanded

Percentage Change in Income

Income Elasticity

Types of Goods

a. Normal Goods

b. Inferior Goods

Higher income raises the quantity demanded for normal goods but lowersthe quantity demanded for inferior goods.

Part3: Elasticity of Supply


Elasticity of Supply: Price

Price Elasticity of Supply

Defn: The percentage change in quantity supplied resulting from a percent change in price.

It is a measure of how much the quantity supplied of a good responds to a change in the price of that good.

Determinants of Elasticity of Supply

a. Ability of sellers to change the amount of the good they produce.

Beach-front land is inelastic. Books, cars, or manufactured goods are elastic.

b. Time period.

Supply is more elastic in the long run.


Elasticity of Supply: Computing the Price Elasticity of Supply

Ranges of Elasticity

a. Perfectly Elastic

ES =

b. Relatively Elastic

ES > 1

c. Unit Elastic

ES = 1

Elasticity of Supply =Percentage Change in Quantity Supplied


The Price Elasticity of Supply is,

computed as the percentage change in the quantity supplied divided by the percentage change in price.

d. Relatively Inelastic

ES < 1

e. Perfectly Inelastic

ES = 0


Elasticity of Supply: Perfectly Inelastic Supply-Elasticity Equals 0

100

Supply

Quantity

2. ...leaves the quantity supplied unchanged

Price

1. An $5

increase

in price... 4


Elasticity of Supply: Inelastic Supply-Elasticity is Less than 1

Quantity

Price

1. A 22% $5

increase

in price... 4

Supply

100 1102. ...leads to a 10% increase in quantity


Elasticity of Supply: Unit Elastic Supply-Elasticity Equals 1

Quantity

Price

$5

4

Supply


1. A 22%

increase in

price


Elasticity of Supply: Elastic Supply-Elasticity is Greater than 1

Price

1. A 22% $5

increasein price...

4

Supply

100 200Quantity

2. ...leads to a 67% increase in quantity


Elasticity of Supply: Perfectly Elastic Supply-Elasticity Equals Infinity

Quantity

Supply$4

1. At any price

above $4, quantitysupplied is infinite.

2. At exactly $4,producers willsupply any quantity.

3. At a price below $4,quantity supplied is zero.

Price


Elasticity of Supply: Application

Application of Elasticity

a. Can good news for farming be bad news for farmers?

b. What happens to wheat farmers & the market for wheat when,

university agronomists discover a new wheat hybrid that is more productive than existing varieties?

The application of supply, demand, & elasticity

1. Examine whether the supply or demand curve shifts.

2. Determine the direction of the shift of the curve.

3. Use the supply-and-demand diagram to see how the market

equilibrium changes.


Elasticity of Supply: An Increase in Supply in the Market for Wheat

1000

Demand

Quantity of Wheat

Price ofWheat

S1

$3


Elasticity of Supply: An Increase in Supply in the Market for Wheat (Cont.)

0

Price ofWheat 1. When demand is inelastic,

an increase in supply...

S1S2

2

Demand

100 110 Quantity of Wheat

3. ...and a proportionately smallerincrease in quantity sold. As a result,revenue falls from $300 to $220.

$32. ...leads

to a large

fall in

price...


Elasticity of Supply: Compute Elassticity

Demand is inelastic

-9.5%

40%

100 - 110

3.00 - 2.00ED =

-0.24=

(100+110)/2

(3.00+2.00)/2

Part4: Summary


Summary: Short-Term & Long-Term Elasticity

Short-Term Elasticity & Long-Term Elasticity

Demand

NoEffect of Income Increase on

DemandNon Durable

1. Non Durable E Short Term < E Long Term

2. Durable E Short Term > E Long Term

Income

NoEffect of Income Increase on

DemandNon Durable

1. Non Durable E Short Term < E Long Term

2. Durable E Short Term > E Long Term


Summary: Short-Term & Long-Term Elasticity (Cont.)


Summary: Elasticity

a. Price elasticity of demand measures how much the quantity

demanded responds to changes in the price.

b. If a demand curve is elastic, total revenue falls when the price

rises.

c. If it is inelastic, total revenue rises as the price rises.

d. The price elasticity of supply measures how much the quantity

supplied responds to changes in the price.

e. In most markets, supply is more elastic in the long run than in the

short


Graphical Review: Computing the Price Elasticity of Demand

Demand is price elastic

4 Demand

Quantity1000

Price

$5

50

67 percent

-22 percent= -3=

(100-50)

(100+50)/2

(4.00-5.00)

(4.00+5.00)/2

ED =


Graphical Review: Perfectly Inelastic Demand-Elasticity Equals 0

100

Demand

Quantity

2. ...leaves the quantity demanded unchanged

Price

1. An $5increase

in price... 4


Graphical Review: Inelastic Demand-Elasticity is Less than 1

Quantity

Price

1. A 22% $5

increase

in price... 4

Demand

90 1002. ...leads to a 11% decrease in quantity


Graphical Review: Unit Elastic Demand-Elasticity Equals 1

Price

1. A 22% $5

increase

in price... 4

Demand



Graphical Review: Elastic Demand-Elasticity is Greater than 1

Price

1. A 22% $5

increase

in price... 4

Demand



Graphical Review: Perfectly Elastic Demand-Elasticity Equals Infinity

Demand

Quantity

Price

$4

2. At exactly $4,consumers willbuy any quantity.

3. At a price below $4,quantity demanded is infinite.

1. At any price

above $4, quantitydemanded is zero.


Graphical Review: Elasticity & Total Revenue

Demand

$4

P

0

Price

100

P x Q = $400

(total revenue)

QQuantity


Graphical Review: Elasticity & Total Revenue along a Linear Demand Curve

$3

Quantity0

Price

80

Revenue = $240

Demand$1 Demand

Quantity0

Revenue = $100

100

Price


from $1 to $3...

leads to an increase

in total revenue

from$100 to $240


Graphical Review: Elasticity & Total Revenue along a Linear Demand Curve (Cont.)

Quantity0

Price

$4

50

Demand

Quantity0

Price

Revenue = $100

$5

20

leads to a decreasein total revenue

from$200 to $100

Revenue = $200


from $4 to $5...

Demand


Graphical Review: Perfectly Inelastic Supply-Elasticity Equals 0

100

Supply

Quantity

2. ...leaves the quantity supplied unchanged

Price

1. An $5

increase

in price... 4


Graphical Review: Inelastic Supply-Elasticity is Less than 1

Quantity

Price

1. A 22% $5

increase

in price... 4

Supply



Graphical Review: Unit Elastic Supply-Elasticity Equals 1

Quantity

Price

$5

4

Supply


1. A 22%

increase in

price


Graphical Review: Elastic Supply-Elasticity is Greater than 1

Price

1. A 22% $5

increasein price...

4

Supply

100 200Quantity

2. ...leads to a 67% increase in quantity


Graphical Review: Perfectly Elastic Supply-Elasticity Equals Infinity

Quantity

Supply$4

1. At any price

above $4, quantitysupplied is infinite.

2. At exactly $4,producers willsupply any quantity.

3. At a price below $4,quantity supplied is zero.

Price


Graphical Review: An Increase in Supply in the Market for Wheat

1000

Demand

Quantity of Wheat

Price ofWheat

S1

$3


Graphical Review: An Increase in Supply in the Market for Wheat (Cont.)

0

Price ofWheat 1. When demand is inelastic,

an increase in supply...

S1S2

2

Demand

100 110 Quantity of Wheat

3. ...and a proportionately smallerincrease in quantity sold. As a result,revenue falls from $300 to $220.

$32. ...leads

to a large

fall in

price...


Reference

1. Mankiw (2004) The Market Forces of Supply and

Demand. Web: mankiw.swlearning.com.


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