DEMAND AND SUPPLY ELASTICITY, Slides of Managerial Economics

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DEMAND AND SUPPLY

ELASTICITY

DEMAND

ELASTICITY

ELASTICITY

 Measures the change in one variable in

response to a change in another variable

 Measures the degree of responsiveness of a

dependent variable to changes in any of the

independent variables

 Responsiveness

Elasticity =

Or

=

Types of Elasticity of Demand

A. Price Elasticity

• The percentage change in quantity demanded to a one percent change in price Example: If a 10% increase in Price leads to a 20% decrease in Quantity Demanded

Interpretation: For every 1% change in P, there is a 2% change in Qd.

ANSWER THIS:

If a 8.755% increase in P leads to a 11.473%

decrease in Qd

For every 1% change in P, there is a 1.31% change in Qd.

b. Inelastic Demand

• % change in Qd < % change in P
• Less than 1
• Consumers are not very responsive to changes in P Examples: Medicine, Food c. Unit Elastic Demand
• % change in Qd = % change in P
• Equal to 1

Two Extreme cases:  Perfectly Elastic Demand

• when the Qd changes by a very large percentage in response to an almost zero percentage change in price
• Any price increase would cause demand to fall to zero Examples: Agricultural products, Identical products sold side by side

Price Elasticity & Total Revenue

Total Revenue (TR) = P * Q

• If Demand is elastic (Greater than 1)
• % ▲ Qd > % ▲ P o 10 %↑ in P results in more than 10 %↓ in sales TR ↓ o 10 %↓ in P results in more than 10 %↑ in sales TR ↑

• If Demand is inelastic (Less than 1)
• % ▲ Qd < % ▲ P

o 10 %↑ in P results in less than 10 %↓ in sales TR ↑

o 10 %↓ in P results in less than 10 %↑ in sales TR ↓

• If Demand is unit elastic (Equal to 1)
• % ▲ Qd = % ▲ P o 10 %↑ in P results in 10 %↓ in sales TR does not change o 10 %↓ in P results in 10 %↑ in sales TR does not change

Determinants of Price Elasticity

 Proportion of Income Spent on the Good

• The higher the proportion of income spent on the good, the higher the elasticity of demand.
• Expensive good take a greater proportion of an individual’s income than the inexpensive goods; so expensive good are more elastic Example: Pen and Car

Determinants of Price Elasticity

 The Time Elapsed Since Price Change

(Length of Time)

• Consumers often have more possibilities for

substitutes for a good when a longer time period is

considered.

Example: Price of gasoline doubles

B. Cross Elasticity of Demand

 Measure of the extent to which the quantity demanded of a good changes when the price of a substitute or complement changes, other things remaining the same

The Cross Elasticity of Demand for a Substitute is

positive.