Elasticity – the concept
The responsiveness of one variable to
changes in another
When price rises, what happens
to demand?
Demand falls BUT!
Elasticity – the concept
If price rises by 10% - what happens to
demand?
We know demand will fall By more than 10%?
By less than 10%?
Elasticity measures the extent to
Elasticity
4 basic types used:
Price elasticity of demand Price elasticity of supply
Elasticity
Price Elasticity of Demand
The responsiveness of demand
to changes in price
Where % change in demand
is greater than % change in price – elastic
Where % change in demand is less than %
Elasticity
Price ($)
Quantity Demanded
Elasticity
The Formula:
Ped = % Change in Quantity Demanded___________________________ % Change in Price
If answer is between 0 and -1: the relationship is inelastic
If the answer is between -1 and infinity: the relationship is elastic
Elasticity
Price
Quantity Demanded (000s) D
The importance of elasticity is the information it
provides on the effect on total revenue of changes in price.
$5
100
Total revenue is price x quantity sold. In this
example, TR = £5 x 100,000 = £500,000.
This value is represented by the grey shaded rectangle.
Elasticity
Price
Quantity Demanded (000s) D
If the firm decides to
decrease price to (say) £3, the degree of price
elasticity of the demand curve would determine the extent of the increase in demand and the change therefore in total revenue.
$5
100 $3
140
Elasticity
% Δ Quantity Demanded = +20% Ped = -0.4 (Inelastic)
Total Revenue would fall
Producer decides to lower price to attract sales
Elasticity
Producer decides to reduce price to increase sales
7
% Δ in Price = - 30%
% Δ in Demand = + 300% Ped = - 10 (Elastic)
Total Revenue rises
The Meaning of Price Elasticity
of demand
Elastic Demand: A strong response to a change in price
Unit Elastic demand: A proportional response to a price
change (total amount spent by consumers remains
unchanged)
Elasticity
If demand is
price elastic:
Increasing price
would reduce TR (%Δ Qd > % Δ P)
Reducing price
would increase TR (%Δ Qd > % Δ P)
If demand is
price inelastic:
Increasing price
would increase TR (%Δ Qd < % Δ P)
Reducing price
Total Outlay Method
Total Outlay is a
way to calculate the price elasticity of demand method by looking at the effect of changes in price on the
revenue earned by the producer.
If price and revenue
move in the same direction, demand is inelastic.
If price and revenue
move in the opposite direction, demand is elastic
If revenue remains
unchanged in
response to a price
Total Outlay Method and slope of
a demand curve
Look at Pg 85
Perfectly elastic Demand is where consumers are willing to pay any price in order to obtain a
given quantity of a good or service. The
situation can be represented by a horizontal demand curve.
An apple grower sells apples, along with many other apple growers , at a fruit and vegetable market. The grower can sell the entire load at the going market price. If the grower tries to sell the apples at a price above the going rate he
Perfectly Inelastic demand is where
consumers are willing to pay any price in order to obtain a give quantity of a good or service. This situation can be represented by a vertical demand curve. Example a
Review Question
Factors affecting elasticity of
demand
Whether the good is a luxury or a necessity.
-necessities have relative inelastic demand-even if there is an increase in price, the quantity demanded will not fall to a great extent
Factors affecting elasticity of
demand
Whether the good has any close substitutes. Goods with close substitutes tend to have
highly elastic demand.
If the price increases the demand is is likely to contract more then proportionately.
Goods and Services with few or no close substitutes , such as water supply, would have inelastic demand- even if price
Factors affecting elasticity of
demand
The expenditure on the product as a
proportion of income
Factors affecting elasticity of
demand
The length of time subsequent to a price
change
If the price falls may take time to become aware and adjust to the price change
If it increases, consumers may take time to seek out alternatives and substitute
Factors affecting elasticity of
demand
Whether a good is habit forming (addictive)
or not
Relative inelastic demand.
E.G Price rise in Alcho-pops and cigarettes did not lead to a large decrease in demand.
REVIEW QUESTION 1-3 pg 87
