ELASTICITY OF DEMAND  PRICE ELASTICITY OF DEMAND  CROSS ELASTICITY OF DEMAND  INCOME ELASTICITY OF DEMAND

Price elasticity of Demand  Price increases always cause a decrease in quantity demanded (law of demand).  BUT  For different products, the degree of responsiveness varies from elastic (very responsive) to inelastic (not very responsive).  This responsiveness can be measured in a number of ways Measures responsiveness of changes in quantity demanded to changes in price.

Total revenue method p pp q q q AB C Consider products A, B and C. Price rises by the same amount for each. Quantity demand falls for each - but by a different amount. In A, total revenue (P*Q) has increased after the price rise. In B, TR has remained the same and in C, TR has fallen. d d d A is inelastic B is unitary C is elastic

TOTAL REVENUE METHOD  IF PRICE AND TOTAL REVENUE MOVE IN THE SAME DIRECTION THEN  IF PRICE AND TOTAL REVENUE MOVE IN OPPOSITE DIRECTIONS THEN INELASTIC DEMAND ELASTIC DEMAND

ELASTICITY COEFFICIENT Percentage Change Method  Ed = %Qd / %P  Use this method if you do not have both prices and both quantity demands. Mid Point Method  Ed = Qd Q1+Q2 P1+P2  P This method is more accurate. Use it if you have both quantities and both prices. X

ELASTICITY AT A POINT P P Q Q X Y Z X Y Z To calculate elasticity of demand at point X, measure the distance XY and divide by the distance XZ. If the demand function is a curve you need to draw a tangent line at the point on the curve.

SPECIAL CASES P P Q Q D D PERFECTLY INELASTIC. A change in price brings about no response - no change in quantity demand. PERFECTLY ELASTIC A change in price brings about an infinite response in quantity demand. Ed=0 Ed= 

WHY INELASTIC?  A necessity - either real or reputed.  No close substitutes.  A small % of income spent on it.  Non-durable  Government regulation makes it a compulsory purchase.

WHY ELASTIC ?  Many substitutes  A luxury  A high % of income spent on it.  Durable

CROSS ELASTICITY OF DEMAND  The sign of the coefficient (+ or -) is important.  Ecross = %Qa %Pb or  What would the equation be for the midpoint method? Measures the responsiveness of quantity demanded of one product to changes in the price of another.

Ecross Coefficient  If Ecross < -1 then it indicates that the two products are complements. The lower the number the stronger the complementary relationship.

Ecross Coefficient  If Ecross >1 it indicates that the two products are substitutes. The higher the number the closer the substitute relationship.

Income elasticity of demand  E= %Qd %Y  What would the equation be for the midpoint method? Measures the responsiveness of a change in quantity demanded to a change in income

INFERIOR GOODS  Income inelastic Qd Income E < 0

NORMAL GOODS Qd income E > 1 0 < E < 1 Income elastic Luxury goods Income inelastic Necessity

GIVE REASONS  This person needs new windscreen wipers before she gets her car registered. Comment on the price elasticity. Give 4 reasons.

EXPLAIN  As a persons income increases the % of their income that they spend on food falls.  True or false?  Explain why.

Vocabulary  Measures responsiveness of demand to changes in price of another good.  A good with negative income elasticity. Cross elasticity Inferior goods

Vocabulary  Measures responsiveness of quantitydemand to changes in price.  Measures responsiveness of quantity demand to changes in income Price elasticity Of demand Income elasticity Of demand