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Demand
by
Balaji K
Overview
Elastic Vs Inelastic Demand
Difference between elastic, inelastic, and unitary
elastic demand/supply
Types of Elasticity of Demand
Determinants of price elasticity of demand
Income elasticity
Cross price elasticity of demand
2
Elasticity of Demand
3
Elasticity - Concept
4
Elastic Demand
5
InElastic Demand
25 1 litre
14 1.2 litre
20 1.5 litre
6
Types of Elasticity
1.Price Elasticity
η
a)Perfectly Elastic
D
b)Perfectly Inelastic
c)Relatively Elastic
d)Relatively Inelastic
e)Unit Elasticity of Demand
7
Types of Elasticity
2.Income Elasticity
a)Zero IncomeηElasticity
D
9
Part 1: Price Elasticity of Demand
- Calculation
Base value for percentage changes in price or quantity is always
midway between initial value and new value
Denominator
- Define the percentage change in price from any value P0 to any other
value P1 as ( P 1 −P 0 )
% Change in Price =
( P1 +P 0 )
• Numerator: 2
Q + Q
1
0
2
10
Figure 1: Calculating Price Elasticity of Demand
-- laptop computer demand
Price per
Laptop
D
$3,500
C
3,000
2,500
2,000
B
1,500
A
1,000
D
12
Calculating Price Elasticity of Demand
-- by Total Outlay Method
Price in Rs Quantity Total Outlay
Demanded
4.50 4 18
4 4.5 18
3 6 18
13
Price Elasticity of Demand
-- Categorize Goods
Inelastic Demand
Price elasticity of demand between 0 and -1
% ∆Q
Inelastic Demand ⇒ < 1.0
%∆P
|% Change in Quantity Demanded| < |% Change in Price|
14
Categorizing Goods by Elasticity
• Elastic Demand
– Price elasticity of demand with absolute value > 1
% ∆Q
Elastic Demand ⇒ >1
%∆ P
|% Change in Quantity Demanded| > |% Change in Price|
15
Figure 2: Extreme Cases of Demand
(a) (b)
Price Price
per per
Unit Unit
D
$4 $4
Perfectly Elastic
3 3 Demand
Perfectly Inelastic
Demand
2 2 D
1 1
20 40 60 80 100 20 40 60 80 100
Quantity Quantity
16
Perfectly Elastic Demand Curve
The demand curve is horizontal, any change in price can and
will cause consumers to change their consumption.
17
Figure 3: Relationship between demand
slope and elasticity
Elasticity = |(1/slope)*(P/Q)|
Perfectly elastic
18
Elasticity Along a Demand Curve
Elasticity declines
Ed = ∞ Perfectly Elastic along demand curve
$10 as we move toward
9 the quantity axis
8 Ed > 1 Relatively
Elastic
7
6
Price
Unit Elastic
Ed = 1
5
4 Relatively Inelastic
3 Ed < 1
2 Perfectly Inelastic
1 Ed = 0
0 1 2 3 4 5 6 7 8 9 10 Quantity
Elasticity and Total Revenue
Total revenue (TR) of all firms is defined as
TR = P x Q
Rule: when two numbers are both changing, percentage
change in their product is (approximately) the sum of their
individual percentage changes
Applying this to total revenue
%∆TR = %∆Q + %∆P
Example: assume demand is unitary elastic and Q rises by
10%
% Change in TR = 10% + (-10%) = 0
20
Figure 4(a): When does it pay to raise the
price?
Price increases from P0 to P1 and quantity
demanded decreases from Q0 to Q1
PRICE
P1
P0
Demand
Quantity
Q1 Q0
21
Figure 4(b): When does it pay to raise the
price?
How about revenue change?
Change in total revenue =
PRICE
P1Q1-P0Q0
P1
P0
Demand
Quantity
Q1 Q0
22
Figure 4(c): When does it pay to raise the
price?
How much is the change in total revenue?
Change in total revenue =
PRICE
P1Q1-P0Q0
Demand
Quantity
Q1 Q0
23
Figure 5 Effects of Price Changes on Expenditure
W h e r e d e m A ap nr i d c e i si n : c r eA pa sr i e c e w di l el : c r e
I n e l (a | s | t< i1 c ) i n c r e xa ps e n d d i t eu cr er e a s e e
u n i et a l a r y( s | t i | c= 1 ) c a u s e n o c ch a a un n so g e e c h i n a n g
e x p e n d i t u r e e x p e n d i t
e l a ( s| t i| c> 1 ) d e c r e a s e e i nx cp re e n a d s i et u er e x
24
Elasticity & Straight-Line Demand Curves
Look at percentage change in P
Look at percentage change in Q
As we move upward and leftward by equal distances,
percentage change in quantity rises
Percentage change in price falls
Elasticity of demand varies along a straight-line demand
curve
Demand becomes more elastic as we move upward
and leftward
25
10
PRICE
| ED | > 1
ED = 1 (
• P
slope Q
)
elastic (1/ slope) = 5 = fixed
8
As P increases, Q falls,
elasticity gets bigger
6
| ED | = 1
Unit elastic
45
| ED | < 1
2 inelastic
0
0 10 20 30 40 50
QUANTITY
25
26
Small Summary
Inelastic Unitary Elastic Elastic Demand
Demand Demand
27
What Affects Elasticity?
-- 1. Availability of Substitutes
Demand is more elastic
Ifclose substitutes are easy to find and buyers
can cut back on purchases of the good in
question
Demand is less elastic
If
close substitutes are difficult to find and
buyers can not cut back on purchases of the
good in question
28
What Affects Elasticity?
-- 2. Narrowness of Market
More narrowly we define a good, easier it
is to find substitutes
More elastic is demand for the good
More broadly we define a good
Harder it is to find substitutes and the less
elastic is demand for the good
Different things are assumed constant
when we use a narrow definition
compared with a broader definition
29
What Affects Elasticity?
-- 3.Necessities vs. Luxuries
The more “necessary” we regard an item, the
harder it is to find a substitute
Expect it to be less price elastic
The less “necessary” (luxurious) we regard an
item, the easier it can be substituted
Expect it to be more price elastic
Example?
30
What Affects Elasticity?
-- 4. Time Horizon
Short-run elasticity
Measured a short time after a price change
Long-run elasticity
Measured a year or more after a price change
Usually easier to find substitutes for an item in
the long run than in the short run
Therefore, demand tends to be more elastic in the
long run than in the short run
31
What Affects Elasticity?
-- 5. Importance in the Buyer’s Budget
The more of their total budgets that
households spend on an item
The more elastic is demand for that item
The less of their total budgets that
households spend on an item
The less elastic is demand for that item
32
Importance of Elasticity of Demand
Price Fixation
Production
Distribution
International Trade
Public Finance
33
Figure 6 Some Short-Run Price Elasticities of
Demand elastic
S p e cB i fr i a c n d s N a r rC o aw t e g o r i e s B r o C a ad t e g o r i e
T i d De e t e r g – 2e .9n 7 t T r a n s a t l a n t i –c 1 .0A 3 i r RT r e a c v r ee l a – 1t i o. 0 n 9
T o u r i s m in T – 1 h .0a 2 i la n d
Pe p s i –2 . 0 8 G r o Bu ne de f –1 . 0 2 C l o t h i n – g0 . 8 9
C o k e – 1 .1 7 Po r k – 0 .8 7 Fo o d – 0 .7 6
M ilk – 0 .4 5 I m p o r t s – 0 .8 5
C ig a r e t t e s –0 . 4 5 T r a n s p –o 0 r .6 t 5 a t i o
E l e c t r i c i t y – 0 . 4t o 0– 0 .0 5
B e e r – 0 .6 2
E g g s – 0 .6 2
G a s o li n e – 0 .0 2
O il – 0 .5 1
inelastic
34
Part 2: Income Elasticity of Demand
Percentage change in quantity demanded
divided by the percentage change in income
With all other influences on demand with the price of
the good kept constant
% change in Quantity Demanded
ηY = % Change in Income
% ∆Q
=
% ∆Y
36
Income Elasticity of Demand
Economic necessity
Good with an income elasticity of demand between 0 and 1
Economic luxury
Good with an income elasticity of demand greater than 1
An implication
As income rises, proportion of income spent on economic
necessities will fall
While proportion of income spent on economic luxuries will rise
But, it is important to remember that economic
necessities and luxuries are categorized by actual
consumer behavior
Not by our judgment of a good’s importance to human survival
37
Income Elasticity of Demand
Zero Income Elasticity
Quantity demanded remains the same, even though money income increases. E=0
Unit Elasticity
When an increase in income brings about a proportionate increase in quantity demanded
,then income elasticity of demand is equal to 1(E=1)
38
Figure 9 Some Income Elasticities
I n c o m e I n c o m e
G o o d o r S e r v Ei c l ea s t i c i t y G o oo rSd e r v i c e E l a s t i c i t y
Fr e sF r hu i t 1 . 9 9 I m p o r t s 2 .3 7
C o m p u t e r s 1 .1 7
T r a n s a t l a n t ic A 1 i r. 4 T 0 r a v eT l r a n s p o r t a t i o 1 n .9 7
C o l l Ee gd eu c a t io n 0 .5 5
C ig a r e t t e s 0 .0 5 R e c r e a t io n 1 .7 0
C h ic k e n 0 . 4 2 C lo t h in g 1 . 0 2
P o r k 0 .4 3 Fo o d 0 . 6 t o 00 . 8 5
F r e s h V e g e t a b 0 l e .6 2s
T o o t h E x t r a c –t 0i o .3 1nt o 0 .7 4
G r o u n d B e e f – 0 .0 2
B r e a d –0 . 4 2
P o t a t o e s – 0 .1 8 Luxury (>1), Necessity (0<EY <1),
Normal (>0) and Inferior (<0)
Goods defined by Income
elasticties
39
Part 3: Cross-Price Elasticity of Demand
Cross-price elasticity of demand
Percentage change in quantity demanded of one good (x)
caused by a 1% change in price of another good (z)
While all other influences on demand remain unchanged
% ∆Qx
η XZ = %∆Pz
• % Change in Quantity of Prod X / %Change in Price of
Prod Y
• Substitutes (+)
• Complements (-)
ηxztwo goods are related
• Its size tells us how closely the
– A large absolute value for suggests that the two goods
are close substitutes or complements
40
k Y ou
Th a n
41