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Lecture 3 Elasticity

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General Concept Elasticity means responsiveness. It shows how responsive one variable is due to the change in another variable. In economics, elasticity is the measurement of how changing one economic variable affects others. For example: "If I lower the price of my product, how much more will I sell?“ Or, "If I raise the price, how much less will I sell?”

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General Formula Suppose, X is the independent variable and Y is the dependent variable. So when X changes it leads to a change in Y. Elasticity shows how responsive Y is to the change of X. How to calculate elasticity? Elasticity is the percentage change in Y due to 1% percentage change in X. Formula: Elasticity =

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Types of Elasticity There are two broad type of elasticity 1)Price Elasticity 2) Income Elasticity Price elasticity can be classified as: a)Own price elasticity b) Cross price elasticity

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Own Price Elasticity a) Own Price Elasticity: Here we consider how a change in the price of a good affects the quantity ( demanded or supplied) of that good. Definition: It is the percentage change of quantity due to the 1% change in its own price. Formula: Own Price Elasticity=

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Cross Price Elasticity b) Cross Price Elasticity: Here we consider how a change in the price of a good affects the quantity ( demanded or supplied) of another good. Definition: It is the percentage change of quantity of a good due to the 1% change in the price of another good. Formula: Cross Price Elasticity= Where, P1 is the price of good 1 and Q1 is the quantity of good 1 P2 is the price of good2 and Q2 is the quantity of good 2 If the two goods are substitute goods then the elasticity will be positive. If the two goods are complementary goods then the elasticity will be negative.

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Income Elasticity It shows how a change in income of a consumer affects the quantity demanded of a good. Definition: It is the percentage change of quantity demanded of a good due to the 1% change in the income of a consumer. Formula: Income Elasticity= Here m is income

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Value and Sign of Elasticity Price Elasticity of Demand: Own Price elasticity of demand is always negative (sign). Why? -Because of negative relationship between price and quantity demanded. -The range of value of price elasticity of demand is from 0 to negative infinity. Price Elasticity of Supply: Own Price elasticity of supply is always positive (Sign). Why? -Because of positive relationship between price and quantity supplied. - The range of value of price elasticity of supply is from 0 to positive infinity.

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Elastic Demand: It means that 1% increase in price leads to a decrease in quantity demanded by more than 1%. The value of elastic demand is between -1 and negative infinity. Inelastic Demand: It means that 1% increase in price leads to a decrease in quantity demanded by less than 1%. The value of inelastic demand is in between 0 and -1. Unit Elastic Demand: It means that 1% increase in price leads to a decrease in quantity demanded by exactly 1%. The value of inelastic demand is exactly -1.

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Elastic Supply: It means that 1% increase in price leads to an increase in quantity supplied by more than 1%. The value of elastic supply is between 1 and positive infinity. Inelastic Supply: It means that 1% increase in price leads to an increase in quantity supplied by less than 1%. The value of elastic supply is in between 0 and 1. Unit Elastic Supply: It means that 1% increase in price leads to an increase in quantity supplied by exactly 1%. The value of unit elastic supply is exactly 1.

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The Price Elasticity of Demand (a) Perfectly Inelastic Demand: Elasticity Equals 0 $5 4 Quantity Demand 100 0 1. An increase in price... 2.... leaves the quantity demanded unchanged. Price

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The Price Elasticity of Demand (b) Perfectly Elastic Demand: Elasticity Equals Infinity Quantity 0 Price $4 Demand 2. At exactly $4, consumers will buy any quantity. 1. At any price above $4, quantity demanded is zero. 3. At a price below $4, quantity demanded is infinite.

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Exercise PeriodPrice Toyota Quantity Demanded Toyota 1 st 2080 2 nd 3020 Find Elasticity and interpret (whether you have elastic, inelastic or unit elastic demand/ supply) Own Price Elasticity of Demand Example: 1 PeriodPrice ToyotaQuantity Supplied Toyota 1 st 1020 2 nd 2060 Own Price Elasticity of Supply Example: 2

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PeriodPrice of Honda Quantity Demanded Toyota 1 st 20 2 nd 4080 PeriodPrice of sugarQuantity Demanded Tea 1 st 1020 2 nd 3010 Cross Price Elasticity Example: 3 and 4 PeriodIncome Quantity Demanded Toyota 1 st 10030 2 nd 20090 Income Elasticity: Example: 5

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