Presentation on theme: "Elasticity! Boingy, boingy, boingy!"— Presentation transcript:
1 Elasticity! Boingy, boingy, boingy! Price, Income and Cross Elasticity
2 Elasticity – the concept The responsiveness of one variable to changes in anotherWhen price rises what happens to quantity demanded?Demand fallsBUT!How much does demand fall?
3 Elasticity – the concept If price rises by 10% - what happens to Qd?We know Qd will fallBy more than 10%?By less than 10%?Elasticity measures the extent to which quantity demanded will change
4 Elasticity 4 basic types used: Price elasticity of demand – PED Price elasticity of supply – PESIncome elasticity of demand – YEDCross elasticity – Cross ED or XED
5 Elasticity Price Elasticity of Demand The responsiveness of quantity demanded to changes in priceWhere % change in Qd is greater than % change in price – elasticWhere % change in Qd is less than % change in price - inelastic
6 Elasticity The Formula: % Change in Quantity Demanded ___________________________Ped =% Change in PriceIf answer is between 0 and -1: the relationship is inelasticIf the answer is between -1 and infinity: the relationship is elasticNote: PED has – sign in front of it; because as price risesdemand falls and vice-versa (inverse relationship betweenprice and demand)
7 Elasticity Price (£) Quantity Demanded The demand curve can be a range of shapes each of which is associated with a different relationship between price and the quantity demanded.Quantity Demanded
8 Elasticity Total Revenue Price £5 D 100 Quantity Demanded (000s) 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.The importance of elasticity is the information it provides on the effect on total revenue of changes in price.£5Total RevenueD100Quantity Demanded (000s)
9 Elasticity D Total Revenue Price £5 £3 100 140 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£3Total RevenueD100140Quantity Demanded (000s)
10 Elasticity % Δ Price = -50% % Δ Quantity Demanded = +20% Producer decides to lower price to attract sales10% Δ Price = -50%% Δ Quantity Demanded = +20%Ped = -0.4 (Inelastic)Total Revenue would fall5Not a good move!D56Quantity Demanded
11 Elasticity Producer decides to reduce price to increase sales % Δ in Price = - 30%% Δ in Demand = + 300%Ped = - 10 (Elastic)Total Revenue rises10Good Move!7D520Quantity Demanded
12 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 would reduce TR (%Δ Qd < % Δ P)
13 Elasticity Versus Slope Elasticity of demand describes the shape of a demand curve, but it is not the same as slope.Slope measures the rise or fall in a curve divided by its horizontal run.Elasticity measures the horizontal run by the rise or fall.
14 Task #1 – Calculating PED Calculate the price elasticity of demand in each of the following examples:The change in demand is 5%, the change in price is 7%The change in demand is 12%, the change in price is 3%The change in demand is 9%, the change in price is 4%The change in demand is 13%, the change in price is 25%The change in demand is 6%, the change in price is 8%In each case say whether the price elasticity is inelastic or elastic.
15 Spending and Elasticity If demand is inelastic, buyers spend more on the good when its price is higher.If demand is elastic, buyers spend less on the good when its price is higher.If demand is unit-elastic, buyers spend the same amount on the good when its price is higher.
16 Determinants of Elasticity Time period – the longer the time under consideration the more elastic a good is likely to beNumber and closeness of substitutes – the greater the number of substitutes the more elasticThe proportion of income taken up by the product – the smaller the proportion the more inelasticLuxury or Necessity - for example, addictive drugs
17 Factors Affecting Elasticity of Demand Availability of Substitutes· Demand for a good is more elastic when close substitutes for it are available to buyers.
18 Factors Affecting Elasticity of Demand Fraction of Income Spent on the Good· As people spend higher fractions of their incomes on a good, their demand for the good becomes more elastic.· As they spend smaller fractions of their income on a good, their demand for it becomes less elastic.
19 Factors Affecting Elasticity of Demand Adjustment Time· Demand is more elastic when people have more time available to adjust to a change in price.
20 Other Types of Elasticity Explain how to calculate Income Elasticity of Demand (YED), Cross-Price Elasticity of Demand (XED) and Price Elasticity of Supply (PES)
21 Elasticity – YED Income Elasticity of Demand (YED): The responsiveness of demand to changes in incomesNormal Good – demand rises as income rises and vice versaInferior Good – demand falls as income rises and vice versa
22 Elasticity – YED Income Elasticity of Demand: A positive sign denotes a normal goodA negative sign denotes an inferior good
23 Elasticity – YED For example: Yed = - 0.6: Good is an inferior good but inelastic – a rise in income of 3% would lead to demand falling by 1.8%WHY? Use your YED formula and plug it in:(x/0.03)=-0.6(-0.6)(0.03)=x-0.018=x, or -1.8%Yed = + 0.4: Good is a normal good but inelastic – a rise in incomes of 3% would lead to demand rising by 1.2%Yed = + 1.6: Good is a normal good and elastic – a rise in incomes of 3% would lead to demand rising by 4.8%Yed = - 2.1: Good is an inferior good and elastic – a rise in incomes of 3% would lead to a fall in demand of 6.3%This slide has a ten second gap in between each example to allow the teacher to explain how the figures have been calculated. This gap can be increased or reduced as appropriate using the custom animation tool.
25 Elasticity – XED Cross Elasticity: The responsiveness of demand of one good to changes in the price of a related good – either a substitute or a complement% Δ Qd of good t__________________XED =% Δ Price of good y
26 Elasticity – XED Goods which are complements: Cross Elasticity will have negative sign (inverse relationship between the two)Goods which are substitutes:Cross Elasticity will have a positive sign (positive relationship between the two)
30 Elasticity Price Elasticity of Supply: % Δ Quantity Supplied The responsiveness of supply to changes in priceIf PES is inelastic - it will be difficult for suppliers to react swiftly to changes in priceIf PES is elastic – supply can react quickly to changes in price% Δ Quantity Supplied____________________PES =% Δ Price
33 Importance of Elasticity Relationship between changes in price and total revenueImportance in determining what goods to tax (tax revenue)Importance in analyzing time lags in productionInfluences the behavior of a firmThis slide also has an automatic response with ten second gaps in between each point. At this stage we have tried to keep things as simple as possible but to introduce issues that will be dealt with later in the course.
34 As you go back to read/review Think about how to solve for each: equations, plugging in, what changes might occur given certain valuesThink about what the graphs would look like for eachThink about determinants of each, and how that might affect how the graph looksThink about substitutes, complements, inferior, superior, normal and luxury goods and how they apply to each