1. Introduction to Economics
Lecture#03
Extension of Demand and Supply Analysis

2. PRICE ELASTICITY OF DEMAND
THE LAW OF DEMAND SAYS...
Consumers will buy more when prices go down and less when prices go up
HOW MUCH MORE OR LESS?
DOES IT MATTER?
to whom?
Price Elasticity Provides an Answer

3. Price Elasticity of Demand
The responsiveness of consumers to a price change is measured by a product price elasticity of demand.
It measures how much consumers are willing to move away from any product as its price rises

4.   % Q % P Ed = PRICE ELASTICITY OF DEMAND P D Q d P2 P1 Q2 Q1
Economists compute the price elasticity of demand as percentage change in the quantity demanded divided by the percentage change in prices. P
The percentage change in quantity
Ed =
The percentage change in price %  Q d  % P P2 P1 D Q2 Q1 Q

5.  Ed = Ed = Elimination of the Minus Sign Or equivalently…
PRICE ELASTICITY OF DEMAND
The Price-Elasticity Coefficient and Formula
Ed =
Percentage change in quantity
demanded of product X
Percentage change in price
of product X
Or equivalently…
Ed =
Percentage change in quantity demanded of X
Original quantity demanded of X
Change in price of X 
Original price of X
Elimination of the Minus Sign

6. Types of Elasticity
If modest or small changes in price cause substantial or large changes to quantity demanded then demand is said to be Elastic, than ED >1
If large price changes cause only small changes in quantity of goods purchased the demand for such products is Inelastic, ED < 1
When amount of change in price and resulted change in quantity demand are same it is called Unit Elastic, Ed =1

7. 1. Elastic Demand (Responsive)
when change in price leads to more than proportionate change in quantity demanded
Small decrease in price cause larger increase in quantity demanded
And 1>Ed< ∞
Shape of the curve: Flatter

8. 2. Inelastic Demand (Not responsive)
When change in price causes a less than proportionate change in quantity demanded
When change in price greater than proportionate change in quantity demanded, demand called Inelastic
Than 0<Ed<1
Shape of the demand curve: Steeply sloped (down ward)

9. Unit Elastic Demand
When change in price leads to an equal change in quantity demanded
And Ed=1
Shape of the curve: 45-degree angle

10. Extreme Cases Perfectly Inelastic Demand Perfectly Elastic Demand D1
Ed = 0 Q
Perfectly Elastic Demand P D2
Ed =  Q

11. .04 .02 .01 .02 .02 Ed = = 2 Ed = = .5 Ed = = 1 Interpretations of Ed
PRICE ELASTICITY OF DEMAND
Interpretations of Ed
Elastic Demand
Ed =
.04
.02
= 2
Inelastic Demand
Ed =
.01
.02
= .5
Unit Elastic Demand
Ed =
.02
= 1

12. Elasticity Along a Linear Demand Curve
Ed = 
$10
Elasticity ??? along demand curve as one moves toward the quantity axis 9 8
Ed > 1 7 6
Ed = 1
Price 5 4
DECLINES
Elasticity is not the same as slope.
Elasticity changes along linear supply and demand curves that are not vertical or horizontal —slope does not.
On a demand curve, elasticity is perfectly elastic (E = infinity) at the price intercept.
It becomes smaller as you move down the demand curve until it becomes zero at the quantity intercept. 3
Ed < 1 2 1
Ed = 0 1 2 3 4 5 6 7 8 9 10
Quantity
Professor D. Garvey, Spring 2004

13.  Ed = The Midpoints Formula Measuring the price elasticity of demand
Change in
quantity
Sum of
Quantities/2
price
prices/2 

14. The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities.
The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change.
Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand, using the midpoint formula, would be calculated as:

15. Total Revenue Method
The simplest way to measure price elasticity, it tells us whether demand is elastic, inelastic or unitary
Price elasticity is the response of consumer to price change
In this Total revenue method we find total revenue by multiplying the quantity sold by price
TR=P*Q
TR=Total Revenue, P=Price, Q= Quantity
To find price elasticity of demand we compare the total revenue at one price with the TR at other price

16. Interpretation When P and TR , demand is Elastic
When P and TR , demand is Inelastic
When P and TR is constant, demand is Unit elastic
And Vise versa

17. PRICE ELASTICITY & TOTAL REVENUE
Total revenue rises
with price to a
point...
then declines TR
Ed = 
$10 9 8
Ed > 1 7 6
Ed = 1 5 4 3
Ed < 1 2 1 1 2 3 4 5 6 7 8 9 10
Quantity Demanded

18. Determinants of Price Elasticity of Demand
Availability of close Substitutes
Goods with close substitutes tend to have more elastic demand. A small change in price of such thing can cause large change in demand of other product for example butter or margarine.
Necessities versus Luxuries
Necessities tend to have inelastic demands , whereas luxuries have elastic demands. for example visiting to doctors or purchasing a new house.

19. Time horizon
Some goods tend to have more elastic demand over longer time periods. As in some cases, consumers need time to adjust their demands according to price changes
Proportion of income
Other thing equal, the higher the price of a good relative to consumer incomes, the greater is the price elasticity of demand.

20. Price Elasticity of Supply
The Price Elasticity of Supply measures the responsiveness of producers towards the price changes in the market.
Es=
The percentage change in quantity supply
The percentage change in price

21. Determinant of Elasticity of supply
Mobility of Inputs
The degree of price elasticity of supply depends on how easily and quickly producer can shift resources between alternatives
If producer can shift the resources more easily and quickly to increase the supply in response of higher prices, will have greater elasticity of supply
e.g. A firm’s producing Jeans, dress pants, suits, sweaters etc.
If prices of Jeans increases, the firm’s response to increase in prices of Jeans will depend on its ability to shift the resources from production of other products i.e. dress pants, shirts, suits, sweeter etc. (whose prices are assumed remain constant) to the production of Jeans.

22. Immediate Market Period
After a change in price when time is too short for producer to respond with the quantity supplied
In immediate period supply curve is vertical, which shows that producer unable to increase the supply, even high market price available
No. of producers
More producers there are, the easier it should be for the industry to increase output in response to a price increase. Supply will thus be more elastic.

23. The existence of spare capacity;
The more capacity there is in the industry, the easier it should be to increase output if price goes up. This makes supply more elastic.
Ease of Storing Stocks
If it is easy to stock goods, then if the price rises the firm can sell these stocks and so supply is more elastic. In the case of goods such as fresh products, it may not be easy to store them and so the supply will not be very flexible

24. Cross Elasticity of Demand
The cross elasticity of demand measures how sensitive consumer purchases of one product (say X) are to change in prices of some other product (say Y).
EXY= % change in QX
% change in PY
Positive Sign
Goods are Substitutes
Negative Sign
Goods are Complementary

25. Income Elasticity of Demand
It measures the responsiveness of quantity demanded for a particular product to change in a person’s income Ei = % change in Qd
% change in income
By Income elasticity of demand we find either goods are normal (necessities or luxuries) or inferior
Positive Sign
Goods are Substitutes
Negative Sign
Goods are inferior