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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 = 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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 Spring '11
 ranjanpandey

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