Transcript Chapter 4
Chapter 4 DEMAND ELASTICITY The Concept of Elasticity • In general, elasticity refers to percentage relationship between two variables. • Coefficient of elasticity=percentage change in A / percentage change in B • Price elasticity of Demand=percentage change in Q / percentage change in P • Point elasticity=dQ/dP * P/Q • Arc Elasticity = Q2 – Q1/(Q1+Q2)/2 divided by P2 – P1/(P1+P2)/2 • =(Q2-Q1)/(Q1+Q2)*(P1+P2)/(P2 – P1) • Categories of Elasticity • • • • A) Elastic: Ep>1 (in absolute terms) b) Inelastic? 0<Ep<1 “ c) Unit elastic: Ep=1 D) perfectly elastic: Ep=∞ (D curve is horizontal) • E) perfectly inelastic: Ep=0 (D curve is vertical) Determinants of Elasticity • • • • • Ease of substitution Proportion of total expenditure Durability of product Length of time period Global competition (in recent years, opening of borders increased demand elasticities. Demand Elasticity and Revenue • The relationship between the price elasticity of demand and revenue is: • Price increase • Price decrease • Draw figures here TR↓ TR↑ TR⌐ TR⌐ TR↑ TR↓ Empirical elasticities • Based on empirical research, the following results were obtained: – Coffee: -0.2 in short run; -0.33 long run – Appliences: -0.63 – Meals at restaurant: -2.27 – Computers: -1.44 – Air travel: -1.2 – First class travel:-0.4 – Potatoes: -0.27 – Butter: -0.62 – Peaches: -1.49 – Beer: -0.84 – Wine: -0.55 Explain this in practical terms Cross elasticity of demand • Deals with the impact of a change in the price of related good (substitutes or complements) on the quantity demanded of a particular product. • Potato chips sold by a company are complement to soft drinks sold by the same company. • Ex = % change in Qa / % change in Qb – Ex > 0 substitute – Ex < 0 complement • As a rule of thumb in business, two products are considered good substitutes or complements when Ex > 0.5 Income elasticity • Ey shows the % change in quantity demanded resulting from a 1% change in income. • Empirical studies revealed the following results: – – – – – – Meals at restaurant: 1.6 Air travel: 1.9 Butter: 0.37 Beer: 0.4 Food: 0.5 Eggs: 0.57 • 3 categories: – Ey > 1 superior good – Ey > 0 and < 1 normal good – Ey < 0 inferior good (potatoes and beans) • Income elasticity concept should also be taken into consideration to or new investment projects. The manager should prefer investment for superior goods in a growing economy. Other elasticities • Advertising elasticity is used by marketing consultants and managers. How an increase in advertising expenses would affect his total sales?