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Econ 206(A) Tutorial 3

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Price Elasticity of Demand Relationship between a change in price and the change in demand. The more elastic is demand the greater the change in quantity demanded for a given change in price.

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Computing Price Elasticities of Demand Pε D = 0, perfectly inelastic (quantity does not change with price) Pε D, perfectly elastic (quantity changes infinite amount with small change in price) Pε D < 1, inelastic (quantity changes smaller amount (%) then the change in price (%)) Pε D >1, elastic (quantity changes larger amount (%) then the change in price (%))

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DP Q D P Q D P Q D P Q (b) (d) (c) (a)

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Numerical Examples Pε D = -0.3; –inelastic Pε D = -1.4; –elastic Pε D = -0.5; –inelastic Pε D = -3.2; –elastic –Only absolute values matter (i.e. ignore the `- sign). –We usually expect quantity to go down as price goes up (law of demand), hence negative sign

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Seminar Topic 1 1.Discuss how changes in incomes, tastes and substitutes may affect the elasticity of demand.

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Substitutes and Income Goods with no close substitutes have highly inelastic demand. The higher the proportion of income spend on a good the greater the reduction in consumption if prices increase (more elastic).

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Seminar Topic 2 What does the elasticity of demand suggest about the potential for indirect taxes on products such as alcohol, cigarettes and petrol?

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Seminar Topic 3 Distinguish between the income and substitution effects of a price change for a normal good.

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Income and Substitution Effects As price of a good rises, the purchasing power of income falls. Hence individuals can afford less of the good (Income Effect). As a price of a good rises, substitute goods become relatively more attractive. Individuals demand more substitutes and less of the initial good (Substitution Effect).

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Price elasticity of supply The responsiveness of quantity supplied to a change in price.

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Income elasticity of demand The responsiveness of demand to a change in consumer income Y. If Yε D > 1 then a luxury. If 0

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Cross elasticity of demand How does demand for one good A respond to a change in the price of another good B. >0 (+ve) B is a substitute for A <0 (-ve) B is a complement for A

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