Elasticity Lecture Presentation PDF

4 ELASTICITY Part I Chapter Outline (A) Price Elasticity of Demand (B) Income Elasticity of Demand (C) Cross Elasticity of Demand (D) Elasticity of Supply Introduction Elasticity of demand is a measure of the responsiveness of the quantity demanded from a good to a change i...

4 ELASTICITY Part I Chapter Outline (A) Price Elasticity of Demand (B) Income Elasticity of Demand (C) Cross Elasticity of Demand (D) Elasticity of Supply Introduction Elasticity of demand is a measure of the responsiveness of the quantity demanded from a good to a change in one of its determinants. (A) Price Elasticity of Demand Price elasticity of demand (PED) is concerned with the responsiveness of the quantity demanded from a good whenever the price of that good changes. Elasticity is different from the slope of the demand curve. The slope of a demand curve depends on the units in which we measure the price and the quantity. We can choose these units to make the demand curve steep (with a large slope) or flat (with a small slope). To measure responsiveness, we need a measure that is independent of units of measurement (unit- free measure), and elasticity is such a measure. (A) Price Elasticity of Demand The price elasticity of demand (PED) is a units- free measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buying plans remain the same. How to calculate PED? 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 𝑃𝐸𝐷 = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 If we have good X: %∆ 𝑄𝐷𝑋 𝑃𝐸𝐷𝑋 = %∆ 𝑃𝑋 (A) Price Elasticity of Demand To calculate the price elasticity of demand: We express the change in price as a percentage of the average price and we express the change in the quantity demanded as a percentage of the average quantity demanded to get the same elasticity value regardless of whether the price rises or falls. Thus: ∆𝑄 ∆𝑃 𝑃𝐸𝐷 = [ × 100 ] ÷ [ × 100 ] 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑄 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃 (𝑄2 −𝑄1 ) (𝑃2 −𝑃1 ) =[ 𝑄1 +𝑄2 × 100 ] ÷ [ 𝑃1 +𝑃2 × 100 ] 2 2 (A) Price Elasticity of Demand Example: Given the following demand for pizza, calculate PED. (A) Price Elasticity of Demand Solution: (𝑄2 −𝑄1 ) (𝑃2 −𝑃1 ) 𝑃𝐸𝐷 = [ 𝑄1 +𝑄2 × 100 ] ÷ [ 𝑃1 +𝑃2 × 100 ] 2 2 (11 −9) (19.5 −20.5) =[ 20 × 100 ] ÷ [ 40 × 100 ] 2 2 2 −1 =[ × 100 ] ÷ [ × 100 ] 10 20 = 20% ÷ −5% = −𝟒 Since the absolute value of PED is greater than 1, we can conclude that demand is elastic. (A) Price Elasticity of Demand Notice that: Elasticity is a ratio of percentages, so a change in the units of measurement of price or quantity leaves the elasticity value the same. The formula yields a negative value, because price and quantity move in opposite directions. But it is the magnitude or absolute value that shows how responsive the quantity change has been to a price change. (A) Price Elasticity of Demand Degrees of PED PED ranges from zero to infinity. 1- Elastic demand The percentage change in the quantity demanded is greater than the percentage change in price, so the PED is greater than 1. 2- Inelastic demand The percentage change in the quantity demanded is smaller than the percentage change in price, so the PED is less than 1. (A) Price Elasticity of Demand 3- Unit Elastic demand The percentage change in the quantity demanded equals the percentage change in price, so the PED is equals 1. (A) Price Elasticity of Demand 4- Perfectly Inelastic demand The quantity demanded doesn’t change when the price changes, the price elasticity of demand is zero. The demand is vertical. Example: Life-saving medicines like Insulin. (A) Price Elasticity of Demand 5- Perfectly Elastic demand The percentage change in the quantity demanded is infinitely large when the price barely changes, the price elasticity of demand is infinite. The demand is horizontal. Example: Demand for a perfectly competitive firm