Presentation on theme: " A measure of the responsiveness of one variable (usually quantity demanded or supplied) to a change in another variable Most commonly used elasticity:"— Presentation transcript:
A measure of the responsiveness of one variable (usually quantity demanded or supplied) to a change in another variable Most commonly used elasticity: price elasticity of demand, defined as: Price elasticity of demand =
usually takes negative values ◦ when price grows, quantity demanded decreases ◦ when price decreases, quantity demanded increases the exceptions: ◦ The Veblen effect is one of a family of theoretically possible anomalies in the general theory of demand. It is claimed that some types of high-status goods, such as diamonds or luxury cars, are Veblen goods, in that decreasing their prices decreases people's preference for buying them because they are no longer perceived as exclusive or high status products.  Similarly, a price increase may increase that high status and perception of exclusivity, thereby making the good even more preferable. 
Giffen good the classic example given by Marshall is staple foods of inferior quality, whose demand is driven by poverty, that makes their purchasers unable to afford superior foodstuffs. As the price of the cheap staple food rises, they can no longer afford to supplement their diet with better foods, and must consume more of the staple food. Marshall wrote in the 1895 edition of Principles of Economics: As Mr. Giffen has pointed out, a rise in the price of bread makes so large a drain on the resources of the poorer labouring families and raises so much the marginal utility of money to them, that they are forced to curtail their consumption of meat and the more expensive farinaceous foods: and, bread being still the cheapest food which they can get and will take, they consume more, and not less of it.
Demand is said to be: ◦ elastic when Ed < -1, ◦ unit elastic when Ed = -1, and ◦ inelastic when Ed >-1.
Even small change of price results decreasing of demand till zero
Customers buy the same amount of good, regardless of good’s price
a price increase from $1 to $2 represents a 100% increase in price, a price increase from $2 to $3 represents a 50% increase in price, a price increase from $10 to $11 represents a 10% increase in price. Notice that, even though the price increases by $1 in each case, the percentage change in price becomes smaller when the starting value is larger.
where: ΔQ - change of quantity demanded Q – quantity demanded before price change ΔP – change of price P – price before change
Suppose that quantity demanded falls from 60 to 40 when the price rises from $3 to $5. The price elasticity of demand equls… In this interval, demand is inelastic (since elasticity >- 1).
Total revenue = price times quantity What happens to total revenue if the price rises?
A reduction in price will lead to: ◦ an increase in TR when demand is elastic. ◦ a decrease in TR when demand is inelastic. ◦ an unchanged level of total revenue when demand is unit elastic. Price elasticity of demand =
different customers are charged different prices for the same product, due to differences in price elasticity of demand higher prices for those customers who have the most inelastic demand lower prices for those customers who have a more elastic demand.
Theatres usually charge three different prices for a show. The prices target various age groups, including youth, adults and seniors. The prices fluctuate with the expected income of each age category, with the highest charge going to the adult population. Some companies, such as firms selling alcoholic beverages, produce similar products but try to promote one as a prestige brand with a much higher price.
Price elasticity of demand is relatively high when: close substitutes are available, the good or service is a large share of the consumer's budget, a longer time period is considered, the customers are rather poor.
Price elasticity of demand is relatively low when: There are no close substitutes (e.g. electricity, water) Goods are necessities Customers are rather rich The good or service is a small share of the consumer's budget
The cross-price elasticity of demand between two goods j and k is defined as:
cross-price elasticity is positive if and only if the goods are substitutes cross-price elasticity is negative if and only if the goods are complements.
A good is a normal good if income elasticity > 0. A good is an inferior good if income elasticity < 0.
A good is a luxury good if income elasticity > 1. A good is a necessity good if income elasticity < 1.
Example: perfect competition
short run - period of time in which capital is fixed all inputs are variable in the long run supply will be more elastic in the long run than in the short run since firms can expand or contract their capital in the long run.