Topic 5Concept of ElasticityDefinition of elasticityPrice Elasticity of Demand (PED)Relationship Between PED and Total Revenue (TR)Income Elasticity of DemandCross Elasticity of DemandElasticity of Supply

Definition of ElasticityGeneral definition : Measurement of the magnitude of responsiveness of variable (eg. Qd or Qs) to the change in one of the determinants factor (eg. Price and income)

General Formula :

Types of Elasticity :-

Price Elasticity of DemandDef : measure how much the quantity demanded of a good responds to a change in price of that good.Formula :

~ Qd0 = original quantity demanded~Qd1 = new quantity demanded~P0 = original price level~P1 = new price level~ -ve sign indicates the negative (inverse) relationship between price level & quantity demanded of the goods.

Price Elasticity of DemandDegree of Price ElasticityElastic ( )Shows that % changes in quantity is larger than % changes in priceEg: Goods with high substitutes (toothpaste & clothing)

Example : Given price of Scrabble increase from RM85.00 to RM95.00 with the quantity demand decrease from 105 boxes to 95 boxes. Calculate the price elasticity of demand for this good.

Continue....Price Elasticity of DemandUnitary Elastic ( ) Shows that % changes in quantity is equal as % changes in price

Inelastic ( )Shows that % changes in price is larger than % changes in quantity demandedLow substitution goods eg. Petrol & cigarettes

Continue....Price Elasticity of Demand Perfectly elastic ( ) A condition when at fixed price consumer will buy any quantity. Decrease in P will cause Qd increase by infinite amount. But at any above price P0, quantity demand will be zero.

Perfectly Inelastic ( )Shows that any % changes in P will have no effect on the %changes in Qd. Coefficient = 0Eg goods: insulin for diabetic patients

Continue....Price Elasticity of Demand Exercise1. Given, the price of Book is increase from RM1.50 to RM2.00 with the quantity fall from 27 to 10 unit. Calculate the price elasticity of demand for this good.

2. Given, the price of motorcycle decreasing by 30% from RM4,500 with quantity demanded increase to 150 units from 120 units. Calculate the price elasticity of demand and interpret the coefficient.

DeterminantsAvailability of Substitutes or SubstitutabilityProportion of Consumers Income Spent on a GoodNature of goodsTime DimensionIncome LevelHabits

Continue.... Relationship between PED & TR Relationship between P Elasticity of Demand & TRthe concept of elasticity always associate with total revenueTotal revenue (TR) the amount paid by buyers & received by sellers of a good.The formula : TR = P x Q

* P x Q = RM500 (revenue)

TRPrice (RM)Quantity50100DD is unitary elastic P increase -> TR is same (%change in Qd =% change in P)P0=10, P1=15Q0=15, Q1=10TR0=150, TR1=150.

Continue....Relationship between PED & TR DD is inelasticP increase -> TR increase

P0=6 P1=12Q0=20, Q1=18TR0=120, TR1=144.

DD is elasticP increase -> decrease in TR (%change in Qd >% change in P)

P0=10, P1=12Q0=15, Q1=10TR0=150, TR1=120.

Income Elasticity of DemandSign of the coefficientPositive Normal goods, luxury goods & necessities goods in Y will in Qd for this goods. +ve & greater than 1 luxury +ve & between 0 and 1 normal +ve & = o necessity goodsNegativeInferior goods in Y will in Qd for this goods & vv

Def : measure how much the quantity demanded of a good responds to a change in consumer income.Formula :

~ Qd0 = original quantity demanded~Qd1 = new quantity demanded~Y0 = original income level~Y1 = new income level

Continue... Income Elasticity of DemandResponses of Income ElasticityPerfectly Inelastic

also known as zero income elasticity of demandCondition in which Qd of a product does not change even though Y Example of goods : rice, vegetables, salt

Cooeficient of EYDegree of ElasticityTypes of GoodEY = 0Perfectly inelasticNecessity goodsEY > 1ElasticLuxury Goods0

Continue... Income Elasticity of DemandNegative ElasticCondition in which Qd as Y Example of goods : Giffen goods or inferior goods such as used cars, salted fish & low grade potatoes.

ElasticCondition in which Y , Qd (grater then increasing in Y)Example of goods : antique furniture, luxury cars, gold & jewelry.

InelasticCondition in which as Qd as Y although increasing in Y more faster than Qd.Example of goods : food & clothing

Cross Price Elasticity of DemandSign of the coefficientPositiveThe 2 goods (X & Y) are substitute to each other. Increase in Py will cause increase in Qdx. Example : Vico & Milo, Nissan & Perdana

NegativeImplies this 2 goods are complimentary goods.Increase in Py will cause decrease in Qdx. Example : Tennis rackets & tennis ball.

Def : measure how much the quantity demanded of a good responds to a change in the price of another good. (% Qdx / % Py)Formula :

~ Qdx0= original quantity demanded of good X~Qdx1 = new quantity demanded of good X.~ Py0 = original Price level of good Y~Py1 = new Price level of good Y

Continue... Cross Price Elasticity of DemandExerciseThe following table shows the price of good X and quantity demanded for goods X and Y.

i. Calculate the price elasticity of demand for good X when price increases from RM4 per unit to RM6 per unit.ii. Calculate the cross elasticity of demand for good Y when the price of good X decreases from RM8 per unit to RM6 per unit.What is the relationship between goods X and Y

Equal to 0Implies this 2 goods are independent or unrelated goods.Example : Tennis rackets & petrol.

Sign of ElasticityTypes of Goods (+ve sign)Goods X & Y, substitute goods (-ve sign)Goods X & Y, complimentary goodsExy=0 Goods X & Y, not related goods

Price of Good X (RM/Unit)Quantity of Good X Demanded (units)Quantity of Good Y Demanded (units)102108486664842102

Price Elasticity of SupplyDegree of Price Elasticity of SuppliedElastic ( )Shows that small % change in P will lead to a large % change in Qs.

Def : measure how much the quantity supplied of a good responds to a change in price of that good.Formula :

~ Qs0 = original quantity supplied~Qs1 = new quantity demanded~P0 = original price level~P1 = new price level

Continue....Price Elasticity of SupplyUnitary Elastic ( ) Shows that % changes in P equals the % change in Qs.

Inelastic ( )Shows that large % changes in P will only affect a small % of the Qs.

Continue....Price Elasticity of Supply Perfectly Elastic ( ) Shows an almost zero % in P brings a very large % change in Qs.

Perfectly Inelastic ( )Shows that % changes in P have no effect on the %changes in Qs.

Continue....Price Elasticity of Supply Technology method of productionPerishable

DeterminantsThe time factor involved in making adjustment to supply - very short run - short run - long runChange in the cost of factor of production small changes in cost of FOP, the supply will be less elastic/inelastic ; large changes in cost of FOP, the supply will be elasticPattern usage for factor of production limited or specific usage of FOP, the supply is inelastic ; normal or easily usage of FOP, the supply is elastic