CHAPTER 20 ELASTICITY of DEMAND

1
CHAPTER 20ELASTICITY of DEMAND SUPPLY

• By Amanda Reina
• Sandra Avila

2
Three types of Elasticity

• Price Elasticity
• Cross Elasticity
• Income Elasticity

3
Price Elasticity

• Response of consumers and producers to price
  change
• Price Elasticity of Demand
• Price Elasticity of Supply

4
Price Elasticity of Demand (Formulas)

• Ed
• change in quantity demanded
• of product X
• ____________________________
• change in price of product X

5
Price Elasticity of Demand (Formulas)

• Ed
• change in quantity demanded of X /
• original quantity demanded of X
• __________________________________
• change in price of X / original price of X

6
Price Elasticity of DemandElimination of Minus
Sign

• Price and Quantity demanded are inversely related
  because of the down-sloping of the demand curve.
• Coefficient (first number) of demand Ed will
  ALWAYS be negative (-).
• Take the absolute value.

P
Down-Sloping
0
D1
Q
7
Price Elasticity of DemandExample

• Ed change in quantity demanded
• of product X
• __________________________
• change in price of product

P? Qd ? This means that the numerator in the
formula will be positive and the denominator
negative.
8
Price Elasticity of Demand Interpretations of Ed
Ed change in quantity demanded
of product X
__________________________
change in price of product

• Elastic Demand Ed gt 1
• Inelastic Demand Ed lt 1
• Unit Elasticity Ed 1
• Perfectly Inelastic Ed 0
• Consumers have NO response to price change
  (Vertical Line)
• Perfectly Elastic Ed 8
• A slight price fall causes consumers to increase
  their purchases from 0 to all they can get
  (Horizontal Line)

9
Mid-Point Formula

• Ed Change in quantity /(sum of
  quantities/2)
• Change in price /(sum of prices/2)

10
Graphical Analysis

• Demand is
• Elastic with high prices (lower quantity)
• Inelastic with low prices (higher quantity)

11
Total Revenue Test

• TR P X Q
• P Price
• Q Quantity

12
Total Revenue Test

• Elastic
• ?P TR?
• Inelastic
• ?P TR ?

13
Example
Price ()
Elastic Ed gt 1
5 4
Unit Elastic Ed 1
Inelastic Ed lt 1
4 5
Quantity Demanded
14
(No Transcript)
15
Determinants of Price Elasticity of Demand

• Substitutability
• Higher of Substitute goods greater Ed
• Proportion of Income
• Higher price of good relative to consumers
  income greater Ed
• Luxuries v. Necessities
• The more the good is luxury the greater Ed is
• Time
• Longer time period greater Ed

16
Price Elasticity of Supply

• Response of consumers and producers to price
  change
• Es change in quantity supplied
• of product X
• ____________________________
• change in price of product X

17
Degree of Price Elasticity of Supply

• How quickly and easily producers can shift
  resources b/w alternative uses
• The longer the time, the greater the resource
  shiftability.

18
Impact of time on Elasticity of Supply

• Immediate market period
• Period that occurs immediately after a change in
  market price, where it is too soon for producers
  to respond with a change in quantity supplied
• Perfectly inelastic supply

P
Sm
Pm
P0
D2
D1
Q
0
Qo
19
Impact of time on Elasticity of Supply

• Short run
• Period too short to change plant capacity but
  long enough to use a fixed plant more or less
  intensively

P
Ss
Supply more elastic than market
period
Ps
P0
D2
D1
Q
0
Qo
Qs
20
Impact of time on Elasticity of Supply

• Long run
• Period long enough for all desired adjustments to
  be made

P
SL
Supply is even more elastic
Pl
P0
D2
D1
Q
Qo
Ql
21
Cross Elasticity of Demand

• Measures how sensitive consumer purchases of
  product X are to a change in the price of product
  Y.
• Related products
• Change in income

22
Cross Elasticity of DemandFormula

• Exy
• change in quantity demanded
• of product X
• __________________________
• change in price of product Y

23
Cross Elasticity of Demand

• Substitute goods have a positive Exy
• Sales of X is related to price changes of Y
• Beef and Chicken
• Complementary goods have a negative Exy
• Increase in price X Decrease demand in Y
• Milk and Chocolate powder
• Independent goods have zero Exy
• X and Y are unrelated
• Candy and Books

24
Income Elasticity of Demand

• Measurement of the consumers response to a
  change in their incomes by buying more/less goods
• Ei change in quantity demanded
• change in income

25
Income Elasticity of Demand

• Positive Ei Normal/ Superior Goods
• Qd I move in the same direction
• Negative Ei Inferior Goods
• Qd I move in opposite direction