Ch04 Elasticity And Its Applications PDF

4 ELASTICITY AND ITS APPLICATIONS FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Elasticity And Its Application Elasticity: Allows us to analyze supply and demand with greater precision. Is a measure of how much buyers and...

4 ELASTICITY AND ITS APPLICATIONS FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Elasticity And Its Application Elasticity: Allows us to analyze supply and demand with greater precision. Is a measure of how much buyers and sellers respond to changes in market conditions. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Demand Elasticity Measures the sensitivity of quantity demanded to related factors, such as price, income and related goods. Type of the demand elasticity 1) Price elasticity of demand 2) Income elasticity of demand 3) Cross price elasticity of demand The Price Elasticity Of Demand Price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good. Price elasticity of demand is the percentage change in quantity demanded given a 1- percent change in the price. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  The Price Elasticity of Demand and Its Determinants ◦ Availability of close substitutes. ◦ Necessities versus luxuries. ◦ Definition of the market. ◦ Proportion of income devoted to the product. ◦ Time horizon. Demand tends to be more elastic: The larger the number of close substitutes. If the good is a luxury. The more narrowly defined the market. The longer the time period. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Computing the Price Elasticity of Demand The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price. Percentage change in quantity demanded Price elasticity of demand = Percentage change in price FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Computing the Price Elasticity of Demand Percentage change in quantity demanded Price elasticity of demand = Percentage change in price Example: If the price of an ice cream cone increases from €2.00 to €2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand would be calculated as: (10  8)  100 20% 10  2 (2.20  2.00)  100 10% 2.00 FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Using the Point Elasticity of Demand Method  The formula for point elasticity of demand is given by: FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  The Variety of Demand Curves 1) Price Inelastic Demand ◦ Quantity demanded does not respond strongly to price changes. ◦ Price elasticity of demand is less than one. 2) Price Elastic Demand ◦ Quantity demanded responds strongly to changes in price. ◦ Price elasticity of demand is greater than one. 3) Perfectly Price Inelastic ◦ Quantity demanded does not respond to price changes. 4) Perfectly Price Elastic ◦ Quantity demanded changes infinitely with any change in price. 5) Unit Price Elastic ◦ Quantity demanded changes by the same percentage as the price. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Computing the Price Elasticity of Demand (100 - 50) (100  50)/2 Price ED  (4.00 - 5.00) (4.00  5.00)/2 €5 4  67 percent  -3 Demand - 22 percent 0 50 100 Quantity Demand is price elastic FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Figure 1a. The Price Elasticity of Demand (a) Perfectly Price Inelastic Demand: Elasticity Equals 0 Price Demand €5 4 1. An increase in price... 0 100 Quantity 2.... leaves the quantity demanded unchanged. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Figure 1b. The Price Elasticity of Demand (b) Price Inelastic Demand: Elasticity Is Less Than 1 Price €5 4 1. A 22% Demand increase in price... 0 90 100 Quantity 2.... leads to an 11% decrease in quantity demanded. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Figure 1c. The Price Elasticity of Demand (c) Unit Elastic Demand: Elasticity Equals 1 Price €5 4 1. A 22% Demand increase in price... 0 80 100 Quantity 2.... leads to a 22% decrease in quantity demanded. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Figure 1d. The Price Elasticity of Demand (d) Price Elastic Demand: Elasticity Is Greater Than 1 Price €5 4 Demand 1. A 22% increase in price... 0 50 100 Quantity 2.... leads to a 67% decrease in quantity demanded. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Figure 1e. The Price Elasticity of Demand (e) Perfectly Price Elastic Demand: Elasticity Equals Infinity Price 1. At any price above €4, quantity demanded is zero. €4 Demand 2. At exactly €4, consumers will buy any quantity. 0 Quantity 3. At a price below €4, quantity demanded is infinite. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017 Total Expenditure, Total Revenue and the Price Elasticity of Demand Total expenditure is the amount paid by buyers, computed as the price of the good times the quantity purchased. Total revenue is the amount paid by buyers and received by sellers of a good. Computed as the price of the good times the quantity sold. TR = P x Q FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Figure 2 Total Revenue Price €4 P × Q = €400 P (revenue) Demand 0 100 Quantity FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION Q 9781473725331 © CENGAGE EMEA 2017  Figure 3 How Total Revenue Changes When Price Changes: Price Inelastic Demand With a price inelastic demand curve: An increase in price leads to a decrease in quantity that is proportionately smaller. Thus, total revenue increases. Price Price An Increase in price from €1 … leads to an Increase in to €3 … total revenue from €100 to €240 €3 Revenue = €240 €1 Revenue = €100 Demand Demand 0 100 Quantity 0 80 Quantity  Figure 4 How Total Revenue Changes When Price Changes: Price Elastic Demand With a price elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Thus, total revenue decreases. Price Price An Increase in price from €4 … leads to an decrease in to €5 … total revenue from €200 to €100 €5 €4 Demand Demand Revenue = €200 Revenue = €100 0 50 Quantity 0 20 Quantity Price Elasticity of a Linear Demand Curve  The slope of a linear demand curve is constant, but the elasticity is not. At points with a low price and a high quantity, demand is inelastic. At points with a high price and a low quantity, demand is elastic.  Total revenue also varies at each point along the demand curve. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 © CENGAGE EMEA 2017  Price Elasticity of a Linear Demand Curve linear demand curve Demand curve that is a straight line. The price elasticity of demand depends not only on the slope of the demand curve but also on the price and quantity. The elasticity, therefore, varies along the curve as price and quantity change. Slope is constant for this linear demand curve. Near the top, because price is high and quantity is small, the elasticity is large in magnitude. The elasticity becomes smaller as we move down the curve.  Other Demand Elasticities income elasticity of demand Percentage change in the quantity demanded resulting from a 1-percent increase in income. cross-price elasticity of demand Percentage change in the quantity demanded of one good resulting from a 1-percent increase in the price of another.  Income Elasticity Of Demand Percentage change in the quantity demanded resulting from a 1- percent increase in income. Higher necessity causes income elasticity of demand to lower. Food and beverages, fuel, medicine are more inelastic compared to the cigarettes. On the contrary, income elasticity of demand for cars, domestic appliances, furnitures is higher than 1. Income elasticity of demand ◦ Inferior Goods (Ey0) ◦ Necessity Goods (0