ELASTICITY OF DEMAND

1
ELASTICITY OF DEMAND

• PRICE ELASTICITY OF DEMAND
• CROSS ELASTICITY OF DEMAND
• INCOME ELASTICITY OF DEMAND

2
Price elasticity of Demand
Measures responsiveness of changes in quantity
demanded to changes in price.

• Price increases always cause a decrease in
  quantity demanded (law of demand).
• BUT
• For different products, the degree of
  responsiveness varies from elastic (very
  responsive) to inelastic (not very responsive).
• This responsiveness can be measured in a number
  of ways

3
Total revenue method
d
p
d
p
p
d
q
q
q
A
B
C
Consider products A, B and C. Price rises by the
same amount for each.
Quantity demand falls for each - but by a
different amount.
In A, total revenue (PQ) has increased after the
price rise. In B, TR has remained the same and in
C, TR has fallen.
C is elastic
A is inelastic
B is unitary
4
TOTAL REVENUE METHOD
Demand Price Increase Price Decrease
Elastic Total revenue will decrease Total revenue will increase
Inelastic Total revenue will increase Total revenue will decrease

• IF PRICE AND TOTAL REVENUE MOVE IN OPPOSITE
  DIRECTIONS THEN

• IF PRICE AND TOTAL REVENUE MOVE IN THE SAME
  DIRECTION THEN

INELASTIC DEMAND
ELASTIC DEMAND
5
ELASTICITY COEFFICIENT

• Mid Point Method
• Ed ?Qd
• Q1Q2

• Percentage Change Method
• Ed ?Qd / ?P
• Use this method if you do not have both prices
  and both quantity demands.

P1P2 ?P
X
This method is more accurate. Use it if you have
both quantities and both prices.
6
ELASTICITY AT A POINT
Z
P
Z
P
X
X
Y
Y
Q
Q
To calculate elasticity of demand at point X,
measure the distance XY and divide by the
distance XZ. If the demand function is a curve
you need to draw a tangent line at the point on
the curve.
7
Elastic and Inelastic Demand Curves
Relatively Elastic
Relatively Inelastic
Price()
Price()
Quantity
Quantity
Shows that a change in price will result in a
proportionately larger change in demand
Shows that a change in price will result in a
proportionately small change in demand
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SPECIAL CASES
Ed?
D
Ed0
P
P
D
Q
Q
PERFECTLY ELASTIC A change in price brings about
an infinite response in quantity demand.
PERFECTLY INELASTIC. A change in price brings
about no response - no change in quantity demand.
9
WHY INELASTIC?

• A necessity - either real or reputed.
• No close substitutes.
• A small of income spent on it.
• Non-durable
• Government regulation makes it a compulsory
  purchase.

10
WHY ELASTIC ?

• Many substitutes
• A luxury
• A high of income spent on it.
• Durable

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Workbooks page 19-20
12
CROSS ELASTICITY OF DEMAND
Measures the responsiveness of quantity demanded
of one product to changes in the price of another.

• The sign of the coefficient ( or -) is
  important.
• Ecross ?Qa
• ?Pb or
• What would the equation be for the midpoint
  method?

13
Ecross Coefficient

• If Ecross lt -1 then it indicates that the two
  products are complements. The lower the number
  the stronger the complementary relationship.

14
Ecross Coefficient

• If Ecross gt1 it indicates that the two products
  are substitutes. The higher the number the closer
  the substitute relationship.

15
Income elasticity of demand
Measures the responsiveness of a change in
quantity demanded to a change in income

• E ?Qd
• ?Y
• What would the equation be for the midpoint
  method?

E lt 0.....inferior good
E gt 0....normal good
0ltElt1...necessity
E gt 1...luxury
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INFERIOR GOODS

• Income inelastic

Qd
E lt 0
Income
17
NORMAL GOODS
Qd
Qd
0 lt E lt 1
E gt 1
income
income
Income inelastic Necessity
Income elastic Luxury goods
18
GIVE REASONS

• This person needs new windscreen wipers before
  she gets her car registered. Comment on the price
  elasticity. Give 4 reasons.

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EXPLAIN

• As a persons income increases the of their
  income that they spend on food falls.
• True or false?
• Explain why.

20
Vocabulary

• Measures responsiveness of demand to changes in
  price of another good.
• A good with negative income elasticity.

Cross elasticity
Inferior goods
21
Vocabulary

• Measures responsiveness of quantitydemand to
  changes in price.
• Measures responsiveness of quantity demand to
  changes in income

Price elasticity Of demand
Income elasticity Of demand