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Unformatted text preview: 1 4- 1 ELASTICITY OF DEMAND AND SUPPLY Slides by Alex Stojanovic with additions by Winston Moore 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 Introduction • The previous lectures examined the direction in which price and quantity will change in response to shifts in demand or supply. • Business are often more interested in estimating ‘by how much’ quantity demanded or supplied will change as a result of a price change. 4- 4 Price Elasticity of Demand • The elasticity of demand is defined as the percentage change in quantity demanded divided by the percentage change in price that brought it about: • Many different elasticities are used in economics. To distinguish the one above, we call it the price elasticity of demand. price in change percentage demanded quantity in change percentage = h 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% 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 $0.10 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 of - 0.5. • 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 2 4- 7 Price Elasticity of Demand • Why is the price elasticity of demand negative? • Remember that price elasticity of demand is the ratio of the percentage change in quantity demanded divided by the percentage change in price that brought it about. • For negatively sloped demand curves, therefore, elasticity is negative since price and quantity always change in opposite directions, i.e. a rise in price will cause a reduction in quantity demanded. 4- 8 Quantity Three Constant-elasticity Demand Curves P r ic e D 4- 9 Quantity P r ic e D 1 D Three Constant-elasticity Demand Curves 4- 10 Quantity P r ic e p D 2 D 1 D Three Constant-elasticity Demand Curves 4- 11 • Curve D 1 has zero elasticity: the quantity demanded does not change at all when price changes....
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