ELASTICITY OF DEMAND

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ELASTICITY OF DEMAND

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

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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). For different
  products, the degree of responsiveness varies
  from elastic (very responsive) to inelastic (not
  very responsive).
• Can be measured in a number of ways

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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
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TOTAL REVENUE METHOD

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

• IF PRICE AND TOTAL REVENUE MOVE IN OPPOSITE
  DIRECTIONS THEN

INELASTIC DEMAND
ELASTIC DEMAND
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ELASTICITY COEFFICIENT

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

• Ed
• ?Qd
• Q1Q2 X

P1P2 ?P
This method is more accurate. Use it if you have
both quantities and both prices.
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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.
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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.
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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.

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WHY ELASTIC ?

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

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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?

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Ecross Coefficient

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

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Ecross Coefficient

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

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Income elasticity of demand

• 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
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NORMAL GOODS
Qd
Qd
0 lt E lt 1
E gt 1
income
income
Income inelastic Necessity
Income elastic Luxury goods
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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.

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Vocabulary

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

Cross elasticity
Inferior goods
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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