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Unformatted text preview: 4 1 ELASTICITY OF DEMAND AND SUPPLY Chapter 4 4 2 Learning Outcomes • How the sensitivity of quantity demanded to a change in price is measured by the elasticity of demand and what factors influence it • How elasticity is measured at a point or over a range • How income elasticity is measured and how it varies with different types of goods • How elasticity of supply is measured and what it tells us about conditions of production • Some of the difficulties that arise in trying to estimate various elasticities from sale data 4 3 Elasticity of Demand and Supply • Demand and supply analysis says about the direction of change. • Businessman thinks; If we rise our price sales will fall If income increases, demand will increase. • But the businessman also want to know “By How Much?” • We want to know, how responsive demand is to a rise in price. • Price Elasticity of Demand : The responsiveness of quantity demanded to a change in price. 4 4 Elasticity of Demand • Measuring the responsiveness of demand to price percentage change in quantity demanded • η = percentage change in price • The demand elasticity is measured by the ratio. • For normal, negatively sloped demand curve, the elasticity is negative, but the relative size of the two elasticities are assessed by comparing their absolute values. 4 5 Original New % change Elasticity Good A Good B Quantity Quantity Price Price 100 £1 200 £5 95 £1.10 140 £6 5% 10% 30% 20% 5/10 =  0.5% 30/20 =  1.5% Example: Calculation of Two Demand Elasticities 4 6 • Elasticity is calculated by dividing the percentage change in quantity by the percentage change in price. • Consider good A. • A rise in price of 10p on £1 or 10 percent causes a fall in quantity of 5 units from 100, or 5 percent. • Dividing the 5 percent deduction in quantity by the 10 percent increase in price gives an elasticity of0.5. • Consider good B. • A 30 percent fall in quantity is caused by a 20 percent rise in price, making elasticity –1.5 Calculation of Two Demand Elasticities 4 7 The sign of the measure • When comparing two elasticities, we compare the absolute, not their algebraic values. • If product X has elasticity of – 2 and product Y has elasticity of – 10, we say that product Y has a greater elasticity than product X. • The larger absolute value indicates that quantity demanded is highly responsive to a change in price. 4 8 Interpreting price elasticity of Demand • The value of price elasticity ranges from 0 to infinity. • Elasticity is zero if quantity demanded is unchanged when price changes. • A zero elastic curve is shown by vertical demand curve....
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This note was uploaded on 10/10/2011 for the course ECON c211 taught by Professor Ranjanpandey during the Spring '11 term at Birla Institute of Technology & Science.
 Spring '11
 ranjanpandey

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