5-Business in A Market Environment

PriceElasticityofDemand
Business in a Market Environment
Theresponsivenessofdemandtoachangein price
theresponsivenessofdemandforanindividual firm
Marketdemandcurveforanindividualfirm underperfectcompetition P P
Thedemandforanindividualfirmsproduct
Pm
D1 O
Firm A
Q
P P
D2 D1 O
6 D1
D2
100
Firm A
Firm B
Firm A
Firm B
P P
10 6 D1 O 100 6 D1
D2
D2
100
90100
100
Firm A
Firm B
Firm A
Firm B
P
Theresponsivenessofdemandtoachangein price
theresponsivenessofdemandforanindividualfirm
10 7 6 D1 O 90100
theresponsivenessofmarketdemand
D2
50
100
Firm A
Firm B
Marketsupplyanddemand
S2 S1 b S1
The effect on price of a shift in supply depends on the responsiveness of demand to a change in price.
Price
Price
P2
a
P1 P1
D
O Q1 Quantity O Q2 Q1 Quantity
S2 S1 b
Price P2
S2 S1 b
Price P2
c
P3 P1
a
P1
D'
D'
D
O Q2 Q1 Quantity O Q3 Q2 Q1 Quantity
Measuringelasticityusingthearcmethod
Definingpriceelasticityofdemand(Pd): %QD/%P
theuseofproportionateorpercentagechanges thesign(positiveornegative) thevalue(greaterorlessthanone)
P ()
10
Pd =
m
8
mid P mid Q
7
6
P = 2 Q = 10
Mid P
4
Demand
0 0 10
15 Mid Q
20
30
40
50
Q (000s)
10
10
Pd =
m
8
Q mid Q
10 15
mid P
2 7
8
Pd =
m
=
Q mid Q
mid P
7
6
P = 2 Q = 10
n
P ()
7
6
P = 2 Q = 10
10 2 7 15 10/15 x 7/2
P ()
4
Mid P
Mid P
4
Demand
Demand
0 0 10
15 Mid Q
20
30
40
50
10
Q (000s)
15 Mid Q
20
30
40
50
Q (000s)
10
Pd =
Q
mid Q
m
8
mid P
7
6
P = 2 Q = 10
= = =
10 2 7 15 10/15 x 7/2 70/30 7/3 = 2.33
QIfthepriceofgoodXrisesfrom9to11andasa resultquantitydemandedfallsfrom100unitsto60 units,whatisthepriceelasticityofdemandbetween theseprices?

A. 2/80=0.025 B. 80/2=40 C. 0.2/0.5=0.4
P ()
4
Mid P
Demand
D. 0.5/0.2=2.5 E. 1
0 0 10
15 Mid Q
20
30
40
50
Q (000s)
Thedeterminantsofpriceelasticityofdemand
thenumberandclosenessofsubstitutegoods
closenessofoneproducttoanother closenessofonebrandtoanother
QThepriceelasticityofdemandforholidaysinGreece islikelytobehighbecause
A. B. C. peopletendtobookupalongtimein advance. thereareplentyofdifferentholidays abroadtochoosefrom. expenditureonholidaysaccountfora relativelysmallpartofpeoplestotal income. holidaysathomeprovidenoreal alternative. peopleneedaholidayiftheyareto copewiththeyearaheadandthey preferholidaysabroad.
theproportionofincomespentonthegood time
D. E.
ImportanceofPriceElasticityofDemand toBusinessDecisionmaking
Totalexpenditure
4
Priceelasticityofdemandandafirmssales revenue(TR=PxQ)
P() 2
Consumers total expenditure = firms total revenue = 2 x 3m = 6m

0 1 2 3 4
0 5
Q (millions of units per period of time)
effectsofapricechangeonsalesrevenue
elasticdemand
TRchangesinsamedirectionasquantity
Elasticdemandbetweentwopoints
Expenditure falls as price rises
elasticdemand
P() 5 4
b a D
inelasticdemand
10
20
Inelasticdemandbetweentwopoints
Expenditure rises as price rises
elasticdemand
TRchangesinsamedirectionasquantity P()
inelasticdemand
TRchangesinsamedirectionasprice
D
0 15 20
elasticdemand
elasticdemand
inelasticdemand
inelasticdemand
applicationstopricedecisions
specialcases
Totallyinelasticdemand(PD=0)
D
elasticdemand
TRchangesinsamedirectionasquantity P2
inelasticdemand
P1
specialcases
totallyinelasticdemand
O Q1 Q
Infinitelyelasticdemand(PD=)
elasticdemand
a
P1
b D
inelasticdemand
specialcases
totallyinelasticdemand infinitelyelasticdemand
O Q1 Q2 Q
Unitelasticdemand(PD=1)
elasticdemand
Expenditure stays the same as price changes 20
inelasticdemand
specialcases
totallyinelasticdemand infinitelyelasticdemand unitelasticdemand
8
b D
40
100
OtherElasticitiesofDemand
Incomeelasticityofdemand %QD/%Y
measurement determinants
degreeofnecessityofthegood rateatwhichdesireissatisfied levelofincomeofconsumers
OtherElasticitiesofDemand
Crosspriceelasticityofdemand %QDa/%Pb
measurement determinants
closenessofcomplementsorsubstitutes timeperiod
applicationstobusiness
effectsofchangesincompetitors'pricingstrategy strategiestomakeaproductlesscrosspriceelastic
applicationstobusiness
importanceofperceptionsoftheproduct repositioningaproduct
QIfariseinthepriceofgoodXresultsinthe amountofmoneyspentongoodYremainingthe same,then

A. B. C. D. E. X&Yareperfectsubstitutes. X&Yareperfectcomplements. Thecrosspriceelasticityofdemand forYwithrespecttoXisinfinite. Thecrosspriceelasticityofdemand forYwithrespecttoXis1. Thecrosspriceelasticityofdemand forYwithrespecttoXis0.
PriceElasticityofSupply
Supplycurveswithdifferentpriceelasticityofsupply
P P
S1 S2
S1
P0
P0
Q0
Q0
P P
S1
S1 S2
P1 P1
S2
P0
P0
Q0
Q1
Q0
Q1
Q2
PriceElasticityofSupply
Meaningofpriceelasticityofsupply Measuringpriceelasticityofsupply %QS/%P
elasticandinelasticsupply
A.
QInwhichoneofthefollowingcasesisgoodX likelytohaveamorepriceelasticsupplythangood Y?
Itismorecostlytoshiftfrom producingXtoanotherproduct thanfromYtoanotherproduct. ThesupplyofYisconsideredovera longerperiodoftimethanX. XisaminorbyproductofY. Consumersfinditeasiertofind alternativestoYthantoX. Thecostofproducingextraunits increasesmorerapidlyinthecase ofYthanofX.
B. C. D. E.
Determinantsofpriceelasticityofsupply
amountthatcostsriseasoutputincreases timeperiod
immediate shortrun longrun
Supplyindifferenttimeperiods
P P
P1
P1
D2 D1
O Q1 Q O Q1
D1
Q
P
P
Si b
Si b c
SS
P2
P2 P3
P1
P1
D2 D1
O Q1 Q O Q1 Q3
D2 D1
Q
P
Si b c
SS
TheTimeDimensionofMarketAdjustment Shortrunandlongrunpriceadjustment
SL
P2 P3 P4 P1
shortandlongrunsupplyanddemandcurves
d a
D2 D1
O Q1 Q3 Q4 Q
Responseofsupplytoanincreaseindemand
P P
P1
P1
D2 D1
O Q1 Q O Q1
D1
Q
P P
S short-run
S short-run
b
P2 P1 P2 P3 P1
b c a
S long-run
Supply is more elastic in the long run.
D2 D1
O Q1 Q2 Q O Q1 Q2 Q3
D2 D1
Q
QTheshortrun(retail)supplyoffreshlycut flowersismuchlesselasticthanthatofpotplants because

A. householdsgenerallykeeppotplants muchlongerbeforethrowingthem away. freshflowersaremorelikelytobe purchasedforspecialoccasions. thepriceoffreshlycutflowers fluctuatesmuchmorethanthatof potplants. suppliesoffreshflowersfluctuate muchmorewiththeweatherandthe season. floristscannotkeepfreshlycut flowersaslongaspotplants.
Responseofdemandtoanincreaseinsupply
P
S1
B. C.
a
P1
D.
E.
Q1
P P
S1
S1 S2 a
P1 P1 P2
S2 a b
D short-run
Q1
Q1
Q2
P
S1 S2 a
P1 P3 P2
Demand is more elastic in the long run.
shortandlongrundemandandsupplycurves
c b
Speculation
D long-run
stabilisingspeculation
D short-run
Q2 Q3
Q1
Stabilisingspeculation:initialpricerise
P
Stabilisingspeculation:initialpricerise
P
S1
S1 S2
P2
Speculators believe that the rise in price to P2 is only temporary.
P2
Speculators believe that the rise in price to P2 is only temporary.
P3 P1
c a D2 D1 D3
Q
a D2 D1
P1
Stabilisingspeculation:initialpricefall
P P
Stabilisingspeculation:initialpricefall
S2 S1
Speculators believe that the fall in price to P2 is only temporary.
S1
Speculators believe that the fall in price to P2 is only temporary.
P1
P1 P3
a c
P2
b D2
D1
P2
b D2 D3
D1
Destabilisingspeculation:initialpricerise
shortandlongrundemandandsupplycurves
S1
Speculators believe that the rise in price to P2 signifies a trend.
Speculation
stabilisingspeculation destabilisingspeculation
P2 P1
b a
D1
O
D2
Destabilisingspeculation:initialpricerise
P
Destabilisingspeculation:initialpricefall
P
S2 S1
S1
P3
P2 P1
b a
Speculators believe that the rise in price to P2 signifies a trend.
P1 P2
a b
Speculators believe that the fall in price to P2 signifies a trend.
D3 D1
O
D1 D2
O
D2
Destabilisingspeculation:initialpricefall
P
S1 S2
QIfpeoplespeculateaboutthefuturepriceof houses,theeffect(ceterisparibus)willdefinitelybe whichoneofthefollowing?

A. Stabilising B. Destabilising C. Neutral
P1 P2
a b
Speculators believe that the fall in price to P2 signifies a trend.
P3
c D1 D3 D2
D. Selffulfilling E.
Q
Inflationary
DealingwithUncertainty
Uncertaintyandrisk
definingriskanduncertainty reducingrisksbyholdingstocks
Dealinginfuturesmarkets
sellers
spotprices futureprices
buyers thedeterminantsofthefutureprice roleofspeculatorsinforwardmarkets

5-Business in A Market Environment

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PriceElasticityofDemand

Business in a Market Environment

10 2 7 15 10/15 x 7/2 70/30 7/3 = 2.33

QIfthepriceofgoodXrisesfrom9to11andasa resultquantitydemandedfallsfrom100unitsto60 units,whatisthepriceelasticityofdemandbetween theseprices?

Consumers total expenditure = firms total revenue = 2 x 3m = 6m

Q (millions of units per period of time)

Q (millions of units per period of time)

Q (millions of units per period of time)

Expenditure stays the same as price changes 20

QIfariseinthepriceofgoodXresultsinthe amountofmoneyspentongoodYremainingthe same,then

Supply is more elastic in the long run.

QTheshortrun(retail)supplyoffreshlycut flowersismuchlesselasticthanthatofpotplants because

Speculators believe that the rise in price to P2 is only temporary.

Speculators believe that the rise in price to P2 is only temporary.

Speculators believe that the rise in price to P2 signifies a trend.

Speculators believe that the fall in price to P2 signifies a trend.

QIfpeoplespeculateaboutthefuturepriceof houses,theeffect(ceterisparibus)willdefinitelybe whichoneofthefollowing?

Speculators believe that the fall in price to P2 signifies a trend.

buyers thedeterminantsofthefutureprice roleofspeculatorsinforwardmarkets

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