Transcript Elasticity of Demand

Elasticity
Powerpoint produced by Rachel Farrell (PDST) & Aoife Healion (SHS, Tullamore)
Elasticity of demand
Shows how sensitive demand is to:
1. A change in the price of the good itself
Price Elasticity of Demand (PED)
2. A change in consumers’ income
Income Elasticiy of Demand (YED)
3. A change in the price of another good
Cross Elasticity of Demand (CED)
Price Elasticiy of Demand

Is the percentage/proportionate change in
the demand (quantity) for a good caused
by the percentage/proportionate change in
the price of that good.
PED is measured by using the
following formula:
P1 + P2
Q1 + Q2

Q
P
Where:
 P1 = the original price of the good
 P2 = the new price of the good
 Q1 = the original quantity demanded
 Q2 = the new quantity demanded
 Delta Q = the change in quantity demanded
 Delta P = the change in price
Note 1
A negative (–) number means that the good:
Obeys the law of demand (eg a normal good)
When P
QD or when P QD
Applying this to the formula
– Q
+ P
+ Q
or
–
P
Each gives a
negative number
Note 2
A positive (+) number means that the good
Does not obey the law of demand (eg. a giffen good)
When P
QD or when P QD
Applying this to the formula
+ Q
+ P
or
–
Q
–
P
Each gives a
positive number
Note 3
If the numerical value (ignoring the sign) is >1
then the PED is elastic.
This means that the percentage change in demand is greater than
the percentage change in price.
If the ans is > –1 then it is a Luxury Good (holiday)
ie: even if the price changes slightly there will be a large reduction
in demand.
Elastic Demand Curve (flatter)
The Price Elasticity of
Demand for this product is
elastic.
The change in price causes
a more than proportionate
change in demand.
Degree of slope > 45º.
Price
Luxury goods, e.g. foreign holidays.
D
P2
P1
D
Q2
Q1
Quantity
Note 4
If the result is
< +1 or < –1
then the PED is inelastic.
This means that the percentage change in demand is
less than the percentage change in price.
If the ans is < –1 then it is a Necessity
ie. even if the price change is large the demand will not
change much as people cannot do without it.
Price
Inelastic Demand Curve
(steeper)
The price elasticity of demand
for this product is inelastic.
P2
The change in price has
caused a less than
P1
proportionate change in
quantity demanded.
Degree of slope < 45º.
Necessities, e.g. Domestic
use of electricity.
D
D
Q2
Q1
Quantity
Note 5
If the result is
= +1 or = –1
then the PED is equal to unity or unit elasticity.
This means that the percentage change in demand is
equal to the percentage change in price.
If the ans is = –1 then it is a “Luxury-necessity”
Eg. needs that are really wants, dvd player, I-pod…
Equal to Unity Curve
Price
“Luxury/necessities”, e.g. a freezer.
The price elasticity of
demand for this product
P1
is equal to unity.
The price change has P2
caused demand to
change in direct
proportion to the change
in price.
Degree of slope = 45º.
D
D
Q1
Q2
Quantity
Example 1
2008 Q 1. (b) (iii)
Q
P1= €40
P1 + P2

P2 = €50
P
Q1 + Q2
Q1=60 units
Q2=40 units
40 + 50 X –20 = -1.8
60 + 40
10
Therefore PED is elastic, obeys the law of demand,
eg. luxury good……
Example 2
2007 SQ 3.
Q
P 1 = €1.50
P1 + P2

P 2 = €1.00
P
Q1 + Q2
Q 1 = 50 units
Q 2 = 90 units
1.50 + 1.00 X 40 = - 1.43
50 + 90
- 0.50
Therefore PED is elastic, obeys the law of demand,
eg. luxury good……
Exceptional PED (perfect comp)
Price
P
D
Quantity
In this case any change in price will cause D to fall
to zero.
Thus PED is perfectly elastic (or equal to infinity).
Exceptional PED (vital med)
Price
D
P2
P1
D
Q1
Quantity
In this case any change in price between P1 and P2
will have no effect on the amount demanded.
Thus the PED is perfectly inelastic (or = zero).
Factors affecting elasticity
Necessity = inelastic v luxury = elastic
 Substitute available = elastic v
no substitute available = inelastic
 Alternative uses = elastic
 Durable = elastic v non durable = inelastic

Complementary good




Eg.
Set of golf clubs = dearer = elastic
Golf balls = cheaper = inelastic
The demand for golf balls will be influenced
more by the price of clubs rather than the
balls themselves.


An increase in the price of balls is unlikely
to have much effect on the demand for
balls or clubs.
However an increase in the price of clubs
will affect both the demand for clubs and
balls.
PED of normal goods and
Total Revenue
When PED > 1
You need to decrease price to increase
total revenue (same direction)
When PED < 1
You need to decrease increase price to increase
total revenue (opp dir)
When PED = 1
There is no effect on TR when P changes
Giffen goods and change in TR
For Giffen goods
Price and total revenue always change in the same direction
regardless of the degree of PED.
The demand for Giffen goods goes up when their price is
increased.
As price increases more goods are sold at a higher price
therefore TR must also increase.
The same logic applies to a decrease in price.
Income Elasticity of Demand (YED)
Measures the relationship between a change in
income and the resulting change in demand.
It can be:
Positive (+) = Normal Good, as Y rises D rises
Negative (-) = Inferior Good & Giffen Good, as Y
rises D falls
YED can be
Elastic (> I1I): the change in income causes a more
than proportionate change in demand. (Luxury
Good)
Inelastic (< I1I): the change in income causes a
less than proportionate change in demand.
(Food)
Equal to unity ( = I1I): the change in income
causes a proportionate change in demand.
Measurement of YED
YED is measured by using the following formula:
Y1 + Y2

Q
Y
Where:
Q1 + Q2

Y1 = the original income

Y2 = the new income

Q1 = the original quantity demanded

Q2 = the new quantity demanded

Delta Q = the change in quantity demanded (sign nb)

Delta Y = the change in income (sig nb)
Example






Income went from €200 to €250
Demand went from 5 units to 8 units
200+250 x +3
5+8
+50
+2.07
Normal, Luxury Good
2002 Q 3 (a)



Normal Good Y inc, QD inc (+)
Eg. holiday
Inferior Good Y inc, QD dec (-)
Eg. potatoes
(b)
Let Y = €100
Consumer spends
(40 % of €100) €40 on the good
Y doubles to €200
Consumer spends
(30 % of €200) €60 on the good
Y Inc and QD Inc Normal Good
(c)


YED potatoes
-0.1
YED designer clothes
+2.5
(d) YED = +1.8 Y D
Y expected to rise by 5%
 Demand (Sales) will rise by
1.8 times 5%
 5% X 1.8 = 9%
 20,000 x 9 = 1,800
100
20,000 + 1,800 = 21,800 units

YED = -0.5 Y D
Y expected to rise by 2%
 Demand (Sales) will decrease by
2 times 0.5 %
 0.5 % X
2 = 1%
 10,0000 x 1
= 100
100
10,000 - 100 = 9,900
units

2009 Q 1. (b) (ii)




YED low price meat
-0.1
YED for iphones
+4.6
2009 Q 1 (c)
YED = +2.5 Y D
Y decreases by 8%
 Sales decrease by 2.5 times 8%
 8%X2.5=20%
 Sales falls by 20%
 100,000X20
= 20,000 units
100
 100,000-20,000 = 80,000 units

Uses of YED
Cross Elasticity of Demand (CED)
Cross elasticity of demand measures the
relationship between the change in price of one
good (A) and the resulting change in demand for
another good (B).
+ive = substitute, an inc P A = an inc D B
-ive = complementary, an in P A = dec in D B
> 1 elastic, < 1 inelastic, = 1 unitary
Measurement of CED
CED is measured by using the following formula:
P(A)1 + P(A)2
Q(B)1 + Q(B)2

Q(B)
P(A)
The demand for product B reacts to a change in the price of product A.
Where:

P(A)1 = the original price of A

P(A)2 = the new price of A

Q(B)1 = the original quantity of B

Q(B)2 = the new quantity of B

Delta Q(B) = the change in quantity of B (sign nb)

Delta P(A) = the change in price of A (sign nb)
2006 Q 1 (c)
5+6
10 + 14
X +4
+1
+ 1.83
Substitute, elastic
2003
Q 2 (b)
27 + 23
X
1,200 + 800
+ 2.5
Substitute, elastic
-400
-4
1999 Q 4 (b)
B = +2.5
Substitute, elastic
C = -0.6
Complementary, inelastic
D = + 0.3
Substitute, inelastic
E = -1.4
Complementary, elastic
Closest substitute

+0.3