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Price, Income and Cross Elasticity

1. The document discusses various types of elasticity including price elasticity of demand, income elasticity of demand, cross elasticity, and price elasticity of supply. 2. Elasticity measures the responsiveness of quantity demanded or supplied to changes in its determinants such as price, income, and the price of related goods. 3. The elasticity value provides important information for businesses and governments on how changes in factors like price will affect total revenue.

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38 views24 pages

Price, Income and Cross Elasticity

1. The document discusses various types of elasticity including price elasticity of demand, income elasticity of demand, cross elasticity, and price elasticity of supply. 2. Elasticity measures the responsiveness of quantity demanded or supplied to changes in its determinants such as price, income, and the price of related goods. 3. The elasticity value provides important information for businesses and governments on how changes in factors like price will affect total revenue.

Uploaded by

parthabhi
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Price, Income and Cross Elasticity

Determinants of demand
Tastes and preferences of the consumers Income of the consumer Price of the substitute Number of consumers Expectation of future price-rise Distribution of income Climate and weather

Elasticity the concept


The degree of responsiveness of demand to the change in its determinants When price rises, what happens to demand?
Demand falls BUT! How much does demand fall?

Elasticity the concept


If price rises by 10% - what happens to demand? We know demand will fall By more than 10%? By less than 10%? Elasticity measures the extent to which demand will change

Elasticity
Price elasticity of demand Cross elasticity Income elasticity Advertisement elasticity Elasticity of price expectation

1. Price 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 less than % change in price - inelastic The price elasticity is negative emphasizing the inverse relationship between price and demand.

Elasticity
The Formula: ep = % 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 rises demand falls and vice-versa (inverse relationship between price and demand)

Elasticity
Price ()
The demand curve can be a range of shapes each of which is associated with a different relationship between price and the quantity demanded.

Quantity Demanded

Elasticity
Price
Total revenue is of price x The importance elasticity quantity sold. In this is the information it example, TR = 5 x 100,000 provides on the effect on = 500,000. total revenue of changes in price. This value is represented by the grey shaded rectangle.

Total Revenue

D 100 Quantity Demanded (000s)

Elasticity
Price
If the firm decides to decrease price to (say) 3, the degree of price elasticity of the demand curve would determine the extent of the increase in demand and the change therefore in total revenue.

Total Revenue
D
100 140 Quantity Demanded (000s)

Elasticity
Price () 10

Producer decides to lower price to attract sales

% Price = -50% % Quantity Demanded = +20% ep = -0.4 (Inelastic) Total Revenue would fall

Not a good move!


D
5 6
Quantity Demanded

Elasticity
Price ()

Producer decides to reduce price to increase sales % in Price = - 30% % in Demand = + 300% Ped = - 10 (Elastic) Total Revenue rises Good Move!
D

10 7

Quantity Demanded

20

Elasticity
If demand is price elastic: Increasing price would reduce TR (% Qd > % P) Reducing price would increase TR (% Qd > % P) If demand is price inelastic: Increasing price would increase TR (% Qd < % P) Reducing price would reduce TR (% Qd < % P)

Interpretation
Value Descriptive Terms Perfectly inelastic demand

Ed = 0

- 1 < Ed < 0

Inelastic or relatively inelastic demand


Unit elastic, unit elasticity, unitary elasticity, or unitarily elastic demand Elastic or relatively elastic demand Perfectly elastic demand

Ed = - 1

- < Ed < - 1 Ed = -

Types
Perfectly elastic of demand Perfectly inelastic of demand Unit elasticity of demand Elastic demand Inelastic demand

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 falls as income rises and vice versa

Elasticity
Income Elasticity of Demand:
A positive sign denotes a normal good A negative sign denotes an inferior good

Elasticity
For example: Yed = - 0.6: Good is an inferior good but inelastic a rise in income of 3% would lead to demand falling by 1.8% Yed = + 0.4: Good is a normal good but inelastic a rise in incomes of 3% would lead to demand rising by 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 demand of 6.3%

Elasticity
Cross Elasticity: The responsiveness of demand of one good to changes in the price of a related good either a substitute or a complement
Xed = % Qd of good t __________________ % Price of good y

Elasticity
Goods which are complements:
Cross Elasticity will have negative sign (inverse relationship between the two)

Goods which are substitutes:


Cross Elasticity will have a positive sign (positive relationship between the two)

Elasticity
Price Elasticity of Supply:
The responsiveness of supply to changes in price If Pes is inelastic - it will be difficult for suppliers to react swiftly to changes in price If Pes is elastic supply can react quickly to changes in price
Pes =
% Quantity Supplied ____________________ % Price

Determinants of Elasticity
Time period the longer the time under consideration the more elastic a good is likely to be Number and closeness of substitutes the greater the number of substitutes, the more elastic The proportion of income taken up by the product the smaller the proportion the more inelastic Luxury or Necessity - for example, addictive drugs

Importance of Elasticity
Relationship between changes in price and total revenue Importance in determining what goods to tax (tax revenue) Importance in analysing time lags in production Influences the behaviour of a firm

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