Elasticity Biz

7/30/2019 Elasticity Biz

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http://www.bized.co.uk

Copyright 2006 Biz/ed

Price, Income

and Cross Elasticity

http://www.bized.co.uk/educators/16-19/economics/markets/presentation/elasticity.ppt
http://www.bized.co.uk/educators/16-19/economics/markets/presentation/elasticity.ppthttp://www.bized.co.uk/educators/16-19/economics/markets/presentation/elasticity.ppthttp://www.bized.co.uk/educators/16-19/economics/markets/presentation/elasticity.ppthttp://www.bized.co.uk/educators/16-19/economics/markets/presentation/elasticity.ppthttp://www.bized.co.uk/educators/16-19/economics/markets/presentation/elasticity.ppt


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Elasticity the concept

The responsiveness of one variableto changes in another

When price rises, what happensto demand?

Demand falls BUT! How much does demand fall?


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Elasticity the concept

If price rises by 10% - whathappens to demand?

We know demand will fall By more than 10%? By less than 10%? Elasticity measures the extent

to which demand will change


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Elasticity

4 basic types used: Price elasticity of demand Price elasticity of supply Income elasticity of demand

Cross elasticity


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Elasticity

Price Elasticity of Demand The responsiveness of demand

to changes in price Where % change in demand

is greater than % change in price elastic

Where % change in demand is lessthan % change in price - inelastic


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ElasticityThe Formula:

Ped =% Change in Quantity Demanded ___________________________

% Change in Price

If answer is between 0 and -1: the relationship is inelastic

If the answer is between -1 and infinity: the relationship is elastic

Note: PED has sign in front of it; because as price risesdemand falls and vice-versa (inverse relationship betweenprice and demand)


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ElasticityPrice ()

Quantity Demanded

The demand curve can be arange of shapes each of whichis associated with a differentrelationship between price andthe quantity demanded.


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ElasticityPrice

Quantity Demanded (000s)

D

The importance of elasticityis the information itprovides on the effect ontotal revenue of changes inprice.

5

100

Total revenue is price xquantity sold. In thisexample, TR = 5 x 100,000= 500,000.

This value is represented bythe grey shaded rectangle.

Total Revenue


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ElasticityPrice

Quantity Demanded (000s)

D

If the firm decides todecrease price to (say) 3,the degree of priceelasticity of the demandcurve would determine theextent of the increase indemand and the changetherefore in total revenue.5

100

3

140

Total Revenue


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ElasticityPrice ()

Quantity Demanded

10

D

5

5

6

% Price = -50%

% Quantity Demanded = +20%

Ped = -0.4 (Inelastic)

Total Revenue would fall

Producer decides to lower price to attract sales

Not a good move!


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ElasticityPrice ()

Quantity Demanded

D

10

5 20

Producer decides to reduce price to increase sales

7

% in Price = - 30%% in Demand = + 300%

Ped = - 10 (Elastic)Total Revenue rises

Good Move!


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Elasticity

If demand isprice elastic:

Increasing pricewould reduce TR(% Qd > % P)

Reducing price

would increase TR(% Qd > % P)

If demand isprice inelastic:

Increasing pricewould increase TR(% Qd < % P)

Reducing pricewould reduce TR(% Qd < % P)


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Elasticity

Income Elasticity of Demand: The responsiveness of demand

to changes in incomes Normal Good demand rises

as income rises and vice versa

Inferior Good demand fallsas income rises and vice versa


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Elasticity

Income Elasticity of Demand:

A positive sign denotes a normal good A negative sign denotes an inferior good


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Elasticity For example: Yed = - 0.6: Good is an inferior good but inelastic

a rise in income of 3% would lead to demand fallingby 1.8%

Yed = + 0.4: Good is a normal good but inelastic a rise in incomes of 3% would lead to demand risingby 1.2%

Yed = + 1.6: Good is a normal good and elastic a rise in incomes of 3% would lead to demand rising

by 4.8% Yed = - 2.1: Good is an inferior good and elastic

a rise in incomes of 3% would lead to a fall in demandof 6.3%


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Elasticity

Cross Elasticity: The responsiveness of demand

of one good to changes in the priceof a related good eithera substitute or a complement

Xed =% Qd of good t __________________

% Price of good y


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Elasticity

Goods which are complements : Cross Elasticity will have negative

sign (inverse relationship betweenthe two)

Goods which are substitutes :

Cross Elasticity will have a positivesign (positive relationship betweenthe two)


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Elasticity

Price Elasticity of Supply: The responsiveness of supply to changes

in price If Pes is inelastic - it will be difficult forsuppliers to react swiftly to changes in price

If Pes is elastic supply can react quickly

to changes in price

Pes =% Quantity Supplied ____________________

% Price


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Determinants of Elasticity Time period the longer the time under

consideration the more elastic a good is likelyto be

Number and closeness of substitutes the greater the number of substitutes,the more elastic

The proportion of income taken up by theproduct the smaller the proportion themore inelastic

Luxury or Necessity - for example,addictive drugs


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h d

Importance of Elasticity

Relationship between changesin price and total revenue

Importance in determiningwhat goods to tax (tax revenue)

Importance in analysing time lagsin production

Influences the behaviour of a firm

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Elasticity Biz

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