Scribd
Upload
15 views46 pages

Market Demand and Elasticities

Uploaded by

pdm88hd4bs
Copyright
© © All Rights Reserved
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
15 views46 pages

Market Demand and Elasticities

Uploaded by

pdm88hd4bs
Copyright
© © All Rights Reserved
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
You are on page 1/ 46

Market Demand and

Elasticities
Elasticity of Demand

 Elasticity is a measure of the responsiveness of quantity demanded or


quantity supplied to one of its determinants.
 It is a measure of how much buyers and sellers respond to changes in
market conditions.
 Buyers usually demand more of a good when its price is lower, when
their incomes are higher, when the prices of substitutes for the good are
higher, or when the prices of complements of the good are lower
 Definition:
Elasticity is a numerical measure of the responsiveness of
Quantity Demanded (Qd ) or Quantity Supplied (Qs ) to one of its
determinants.
Elasticity of Demand

 Price elasticity of demand a measure of how much the quantity


demanded responds to a change in the price.
 Own price elasticity
 Cross price elasticity
 Income elasticity of demand measures how much the quantity
demanded of a good responds to a change in consumers’ income.
Price Elasticity of Demand
 Price elasticity of demand is the percentage change in quantity
demanded over a percentage change in the price.

Eg1:
PED = 15%/10% = 1.5
Price Elasticity of Demand

Eg2:
Calculating Percentage Changes

 % % change in QD = -50/100 = 0.5 = -50%


 % change in price =10/50 = 0.2 = 20%
 PED = -50%/ 20% = -2.5
 Note that elasticity is an absolute value, meaning it is not
affected by positive of negative values.
 Therefore PED = 2.5
Midpoint Method

 Eg3: Calculate price elasticity from A to B and from B to A.


Midpoint Method

 Moving from A to B:
 %ΔPrice: The coffee price falls from $4.50 to $3.00, meaning the
percentage change is (3.00−4.50)/4.50 = 33%. Price has fallen by 33%.
 %ΔQuantity: The quantity of coffee sold increases from 4 to 6, meaning
the percentage change is (6−4)/ 4 = 50%. Quantity has risen by 50%
 Elasticity: %Δquantity/ %Δprice = 50%/ 33% = 1.5
Midpoint Method

 Moving from B to A:
 %ΔPrice: The coffee price rises from $3.00 to $4.50, meaning the
percentage change is (4.50−3.00)/ 3.00 = 50%. Price has risen by 50%.
 %ΔQuantity:
The quantity of coffee sold falls from 6 to 4, meaning the percentage
change is (4−6)/ 6 = -33%. Quantity has fallen by 33%
 Elasticity: %Δquantity/ %Δprice = 33%/ 50% = 0.67
Midpoint Method

 These two calculations give us different numbers. This type of analysis


would make elasticity subject to direction which adds unnecessary
complication. To avoid this, we will instead rely on averages.
 To calculate elasticity, instead of using simple percentage changes in
quantity and price, economists use the average percent change. This is
called the mid-point method for elasticity, and is represented in the
following equations:

 The advantage of the mid-point method is that one obtains the same
elasticity between two price points whether there is a price increase or
decrease. This is because the denominator is an average rather than the old
value.
Midpoint Method
 Using the mid-point method to calculate the elasticity between Point A and Point
B:

 This method gives us a sort of average elasticity of demand over two points on
our curve. Notice that our elasticity of 1 falls in-between the elasticities of 0.67
and 1.52 that we calculated in the previous example.
THE PRICE ELASTICITY OF DEMAND
AND ITS DETERMINANTS
 Necessities versus Luxuries
 Availability of Close Substitutes
 Definition of the Market
 Time Horizon
Determinants of Price Elasticity of
Demand
Demand tends to be more elastic if:
 the good is a luxury.
 the longer the time period.
 the larger the number of close substitutes.
 the narrowly defined goods.
THE VARIETY OF DEMAND CURVES

 The price elasticity of demand measures how much quantity demanded


responds to changes in the price, it is closely related to the slope of the
demand curve.
 Rule of Thumb:
 The flatter is the demand curve that passes through a given point, the
greater is the price elasticity of demand.
 The steeper is the demand curve that passes through a given point, the
smaller is the price elasticity of demand.
“Perfectly inelastic demand” (one
extreme case)
“Inelastic demand”
“Unit elastic demand”
“Elastic demand”
“Perfectly elastic demand” (the other
extreme)
Elasticity of a Linear Demand Curve
Properties
Price Elasticity and Total Revenue
Price Elasticity and Total Revenue

 Elastic demand (elasticity 1.8)


Price Elasticity and Total Revenue

 If demand is inelastic, then


price elast. of demand < 1
% change in Q < % change in P
 The fall in revenue from lower Q is smaller than the increase in revenue
from higher P, so revenue rises.
 In our example, suppose that Q only falls to 10 (instead of 8) when you
raise your price to $250.
Price Elasticity and Total Revenue

 Demand is inelastic: elasticity = 0.82


Ranges of Elasticity

 Inelastic Demand
 Percentage change in price is greater than percentage change in
quantity demand.
 Price elasticity of demand is less than one.
 Elastic Demand
 Percentage change in quantity demand is greater than percentage
change in price.
 Price elasticity of demand is greater than one.
Price Elasticity of Supply

 Price elasticity of supply measures how much Qs responds to a change


in P.
Price Elasticity of Supply
The Variety of Supply Curves

 The slope of the supply curve is closely related to price elasticity of


supply.
 Rule of thumb:
• The flatter the curve, the bigger the elasticity.
• The steeper the curve, the smaller the elasticity.
“Perfectly inelastic” (one extreme)
“Inelastic”
“Unit elastic”
“Elastic”
“Perfectly elastic” (the other
extreme)
The Determinants of Supply Elasticity

 The more easily sellers can change the quantity they produce, the
greater the price elasticity of supply.
 Example: Supply of beachfront property is harder to vary and thus less
elastic than supply of new cars.
 For many goods, price elasticity of supply is greater in the long run than
in the short run, because firms can build new factories, or new firms
may be able to enter the market.
Elasticity and changes in equilibrium

 The supply of beachfront property is inelastic. The supply of new cars is


elastic.
 Suppose population growth causes demand for both goods to double (at
each price, Q.D doubles).
 For which product will P change the most?
 For which product will Q change the most?
Cross Price Elasticity
Cross-price elasticity of demand:

 measures the response of demand for one good to changes in the price
of another good

 For substitutes, cross-price elasticity > 0 (e.g., an increase in price of


beef causes an increase in demand for chicken)
 For complements, cross-price elasticity < 0 (e.g., an increase in price of
computers causes decrease in demand for software)
Cross-price elasticity of demand

 An increase in the price of hot dogs from £1.50 to £2.10 per pound
increased the average number of beef burgers demanded per week from
300 to 360 Assuming that all other economic variables were held
constant, calculate the cross-price elasticity of demand between hot
dogs and beef burgers.
Properties
Income Elasticity of Demand

 Income elasticity of demand 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.
Income elasticity of demand
Income elasticity of demand

 measures the response of Qd to a change in consumer income


 An increase in income causes an increase in demand for a normal good.
 Hence, for normal goods, income elasticity > 0.
 For inferior goods, income elasticity < 0.

You might also like