Econ 206(A) Tutorial 3

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.

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 (%))

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

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

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

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).

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

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

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).

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

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

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