the MICROECONOMICS
ECO162
ELASTICITY
Ms.TaiNyukChin
LEARNINGOUTCOMES
At end of this lesson, the students should
beableto:
i.
Explaintheconceptofelasticity.
ii.
Identifythetypesofelasticity.
iii.
iv.
Identify the determinants of elasticity of
demandandsupply.
Define and calculate elasticity of demand
(price,income,cross)andsupply.
ELASTICITY
v
i.
ii.
iii.
iv.
FourtypesofElasticity:
PriceElasticityofDemand
IncomeElasticityofDemand
CrossPriceElasticityofDemand
PriceElasticityofSupply
PRICEELASTICITYOFDEMAND
1.Definition
Itisameasureofhowmuchthequantity
demandedofagoodrespondstoachangein
thepriceofthatgood.
Thepercentagechangeinquantitydemanded
dividedbythepercentagechangeinagoodsprice.
Ed=
2.Measurement:
Ed=
[(Q1QO/QO)] x100
percentagechangeindemand
x100
[(P1PO/PO)]
percentagechangeinprice
ComputingthePriceElasticityof
Demand
in quatity demanded
Price elasticity of demand = Percentage change hange in price
Percentage c
Example:Ifthepriceofanicecreamconeincreasesfrom$2.00to
$2.20 and the amount you buy falls from 10 to 8 cones then your
elasticityofdemandwouldbecalculatedas:
(8 10)
100
20%
10
=
=
2
( 2.20 2.00)
10 %
100
2.00
=2
:.Negativesignisignoredsinceitsonlyindicatesthelawof
demand(Pincrease,Qddecreaseandviceversa)
PRICEELASTICITYOFDEMAND
How responsive is quantity demanded to price
changes?
Doesquantitydemandedchangealot,little,not
atall?
Thereisfive degreeofelasticity todescribehow
responsivedemandis;
i.
Elastic
ii.
Inelastic
iii.
PerfectlyElastic
iv.
PerfectlyInelastic
6
Figure6:DegreeofElasticity(Elasticdemand)
(a) Elastic Demand: Elasticity Is Greater Than 1, Ed > 1
Price
%Qd>%P
Elasticity,Ed>1
$5
4
Demand
1. A 25%
increase
in price . . .
0
50
100
Quantity
2. . . . leads to a 50% decrease in quantity demanded.
Figure7:DegreeofElasticity(InelasticDemand)
(b) Inelastic Demand: Elasticity Is Less Than 1, Ed < 1
Price
%Qd<%P
Elasticity,Ed<1
$5
4
1. A 25%
increase
in price . . .
Demand
0
90
100
Quantity
2. . . . leads to an 10% decrease in quantity demanded.
Figure8:DegreeofElasticity(PerfectlyElastic)
(c) Perfectly Elastic Demand: Elasticity Equals Infinity
Price
Elasticity,Ed=
1. At any price
above $4, quantity
demanded is zero.
$4
Demand
2. At exactly $4,
consumers will
buy any quantity.
0
3. At a price below $4,
quantity demanded is infinite.
Quantity
Figure9:DegreeofElasticity(PerfectlyInelastic)
(d) Perfectly Inelastic Demand: Elasticity Equals 0, Ed = 0
Price
Demand
Elasticity,Ed=0
%P Q=0
,%
$5
4
1. Any
increase
in price . . .
0
100
2. . . . leaves the quantity demanded unchanged.
Quantity
Figure10:DegreeofElasticity(UnitElastic)
(e) Unit Elastic Demand: Elasticity Equals 1
Price
Elasticity,Ed=1
%P=%Q
$5
4
Demand
1. A 25%
increase
in price . . .
0
80
100
Quantity
2. . . . leads to a 25% decrease in quantity demanded.
Determinantsof
PriceElasticityofDemand
i.
.
.
.
Theexistenceofsubstitutes
Goods with close substitutes tend to have more elastic
demandbecauseitiseasierforconsumertochangefrom
thosegoodstoothers.
If there are no substitutes exist, the price elasticity of
demandtendstobeinelastic.
E.g.: Coca cola and Pepsi can easily substitute each other.
Thus, a small increase in the price of Coca cola, assuming
price of Pepsi remain constant, will cause the quantity of
Coca cola sold to decrease by a large amount. This is
because, consumer will purchase Pepsi rather than Coca
cola.
Determinantsof
PriceElasticityofDemand
ii.
.
.
.
Necessitiesvs.Luxuries
Necessities goods tend to have inelastic demands,
whereasluxuriesgoodstendtohaveelasticdemands.
E.g.:PriceelasticityofdemandforRolexwatchiselasticas
Rolex watch is considered as a luxury goods. On the other
hand, rice which is a necessities good tend to have more
inelasticdemand.
WhenpriceofRolexincrease,therewillbealargedecrease
in quantity demanded but if price of rice increase, people
dontdramaticallyaltertheconsumptionofricesincericeis
necessitiesgoods.
Determinantsof
PriceElasticityofDemand
iii.
.
.
.
.
Timehorizon.
Goods tend to have more elastic demand over a longer
periodoftimehorizons.
The shorter the time period, the more inelastic demand
willbecome.
This is because you will have more time to find
substitutes.
E.g.: When the price of fuel increase, the quantity
demanded for fuel falls slightly in the first few months.
Thus the demand in short run is inelastic. However, in
longer period, people will find alternative for fuel such as
fuelefficientcars.Thus,demandtendtobemoreelastic.
Determinantsof
PriceElasticityofDemand
iv.
.
.
Proportionofconsumersexpenditure
Demand tends to be more elastic when a
consumers expenditureontheproductislarge
andviceversa.
E.g.:Demandismoreelasticforproductssuchas
cars as consumers proportion for cars is large
while demand for grocery items tend to be
inelastic as the proportion for this items is
smaller.
PriceElasticityofDemandandTotal
Revenue(TR)
Totalrevenueistheamountpaidbybuyers
andreceivedbysellersofagood.
Computed as the price of the good times
thequantitysold.
TotalRevenue(TR)=Price(P)xQuantity(Q)
TR=PxQ
Figure11:TotalRevenue
Price
$4
P Q = $400
(revenue)
P
0
Demand
100
Q
Quantity
ElasticityandTotalRevenuealonga
LinearDemandCurve
With an inelastic demand curve, an
increase in price leads to a decrease in
quantity that is proportionately smaller.
Thus,totalrevenueincreases.
Figure12HowTotalRevenueChangesWhenPrice
Changes:InelasticDemand
Price
Price
An Increase in price from $1
to $3
leads to an Increase in
total revenue from $100 to
$240
$3
Revenue = $240
$1
Demand
Revenue = $100
0
100
Quantity
Demand
0
80
Quantity
ElasticityandTotalRevenuealonga
LinearDemandCurve
Withanelasticdemandcurve,anincrease
inthepriceleadstoadecreaseinquantity
demanded that is proportionately larger.
Thus,totalrevenuedecreases.
Figure13HowTotalRevenueChangesWhenPrice
Changes:ElasticDemand
Price
Price
An Increase in price from $4
to $5
leads to an decrease in
total revenue from $200 = to
$100
$5
$4
Demand
Demand
Revenue $200
0
Revenue = $100
50
Quantity
0
20
Quantity
CrossPriceElasticityofDemand
Ec=
E
%changeindemandQx
%changeinpriceofQy
c=
[(Q1xQ0x/Q0x)]
[(P1yP0y/P0y)]
P
Elasticitymeasurethatlooksattheimpactofachangein
the price of one good has on the demand of another
good.
Positive: P of Good A increase, Qdd of Good B
increase(Substitutesgoods)
CrossPriceElasticityofDemand
%changeinQdGoodX
x100
Ec=
%changeinpriceofGoodYx100
[(Qdy1Qdy0/Qdy0)]x100
Ec=
x100
[(Px1Px0/Px0)]
Priceof
GoodX
(RM)
Qdfor
GoodY
(Unit)
Qdfor
GoodZ
(Unit)
10
100
100
12
110
70
The Cross Price elasticity of demand for good X if price of Good X
increasefromRM10toRM12:
GoodXandGoodY:
Ec=(110100/100)x100
(1210/10)
x100
=[10/20]
=0.5(Substitutesgood)
:. Positive value indicates that
good X and Good Y is a
substitutesgoods
GoodXandGoodZ:
Ec=(70100/100) x100
(1210/10) x100
=[30/20]
=1.5(Complementgood)
:. Negative value indicates that
Good X and Good Z is a
complementgoods
IncomeElasticityofDemand
Ey= %changeindemandQ
%changeinIncome
Ey
[(Q1Q0/Q0)]
=
[(Y1Y0/Y0)]
Incomeelasticityofdemandmeasureshowmuch
the quantity demanded of a good responds to a
changeinconsumersincome.
It is computed as the percentage change in the
quantity demanded divided by the percentage
IncomeElasticityofDemand
TypesofGoods
i.
NormalGoods
iii.
InferiorGoods
.
IncomeElasticityispositive.
IncomeElasticityisnegative.
Higherincome raises the quantitydemandedfor
normalgoodsbutlowersthequantitydemanded
forinferiorgoods.
IncomeElasticityofDemand
%changeindemandQ x100
Ey=
%changeinIncome x100
[(Q1Q0/Q0)] x100
Ey=
x100
[(Y1Y0/Y0)]
Income
(RM)
QdforGood QdforGood
X
Y
(Unit)
(Unit)
100
100
100
150
110
70
TheincomeelasticityofdemandforgoodXif
incomeincreasefromRM100toRM150:
TheincomeelasticityofdemandforgoodYif
incomeincreasefromRM100toRM150:
x100
Ey=[(110100)/100]
x100
[(150100)/100]
Ey=[(70100)/100]
x100
[(150100)/100]
x100
=(30/50)
=0.6(Inferiorgood)
:. Negative value of Ey indicates
thatgoodYisainferiorgoods.
:. If income increases by 1%,
quantity of good Y demanded
willdecreaseby0.6%
=[10/50]
=0.2(Normalgood)
:.PositivevalueofEyindicatesthat
goodXisanormalgoods.
:. If income increases by 1%,
quantity of good X demanded will
increaseby0.2%
THEELASTICITYOFSUPPLY
Priceelasticityofsupply isameasureofhowmuchthe
quantity supplied ofa good responds to a change inthe
priceofthatgood.
Price elasticity of supply is the percentage change in
quantity supplied resulting from a percent change in
price.
Es= Percentagechangeinquantitysupplied
Percentagechangeinprice
Es=
x100
[(Q1Q0/Q0)]
x100
[(P1P0/P0)]
Figure14ThePriceElasticityofSupply(ElasticSupply)
(a) Elastic Supply: Elasticity Is Greater Than 1 (Es>1)
Price
Supply
$5
4
1. A 25%
increase
in price . . .
%P<
%Q
0
100
200
Quantity
2. . . . leads to a 50% increase in quantity supplied.
Figure15ThePriceElasticityofSupply:InelasticSupply
(b) Inelastic Supply: Elasticity Is Less Than 1 (Es <1)
Price
Supply
$5
4
1. A 25%
increase
in price . . .
0
100
110
Quantity
2. . . . leads to a 10% increase in quantity supplied.
Copyright2003 Southwestern/Thomson Learning
Figure16ThePriceElasticityofSupply:PerfectlyElasticSupply
(c) Perfectly Elastic Supply: Elasticity Equals Infinity (Es = )
Price
1. At any price
above $4, quantity
supplied is infinite.
$4
Supply
2. At exactly $4,
producers will
supply any quantity.
0
3. At a price below $4,
quantity supplied is zero.
Quantity
Copyright2003 Southwestern/Thomson Learning
Figure17ThePriceElasticityofSupply:PerfectlyInelasticSupply
(d) Perfectly Inelastic Supply: Elasticity Equals 0 (Es = 0)
Price
Supply
$5
4
1. An
increase
in price . . .
0
100
Quantity
2. . . . leaves the quantity supplied unchanged.
Copyright2003 Southwestern/Thomson Learning
Figure18ThePriceElasticityofSupply:UnitElasticSupply
(e) Unit Elastic Supply: Elasticity Equals 1 (Es = 1)
Price
Supply
$5
4
1. A 25%
increase
in price . . .
0
100
125
Quantity
2. . . . leads to a 25% increase in quantity supplied.
Copyright2003 Southwestern/Thomson Learning
Determinantsof
PriceElasticityofSupply
i.
P.
.
Flexibilityofsellerstoproduce
Depends on the flexibility on the amount of
goodstheproducerproduces.
Eg:Hillylandhasaninelasticsupplybecauseitis
almost impossible to produce anymore goods.
(Producers are insensitive of price changes as they
cannot produce more to response to a higher
price). Other producers, such as cars have elastic
suppliesastheycanresponsebettertoachangesin
price.
Determinantsof
PriceElasticityofSupply
ii.
.
.
.
Timeperiod
Inlongterm,elasticityofsupplyisusuallymore
elasticthaninshortterm.
In short term, firm cannot easily change the
quantity of goods they wanted to produce and
thismakesthemlessresponsivetopricechanges.
Inlongterm, producerscanchangethequantity
suppliedastheypossessmoretimetoresponseto
pricechanges.
Determinantsof
PriceElasticityofSupply
iii.
.
.
.
Availabilityandmobilityoffactorsof
production
Anincreaseinquantitysuppliedrequiresusing
moreoffactorsofproduction.
Whenfactorsofproductionsuchascapital,labor
aremoremobileandeasilyobtained,supplytend
tobemoreelastic.
However,whenfirmsfaceobstacletoobtain
extrarawmaterialtoproduceadditionaloutput,
theyhaveinelasticsupply.
Determinantsof
PriceElasticityofSupply
iv.
.
.
TechnologyImprovement
Technology advancement help producer to
reduce cost and increase supply. Therefore,
supplytendtobemoreelastic.
Eg: Producer of cars can increase cars production
with help from advanced technology, therefore the
producer can response better when price change
andthismakecarssupplyelastic.
Determinantsof
PriceElasticityofSupply
v.
.
.
.
Perishability
The supply of good is inelastic if the good is
easilyperishable.
Goods, which are easily perishable, are not
sensitivetopricechanges.
E.g:Agriculturalproductscannotbestoredinlong
period, therefore sellers cannot response much in
changesinprice(Inelastic)
Thatsallforchapter3!!!
DomoArigato!