price elasticity of demand

7/18/2019 Price Elasticity of Demand

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Price Elasticity of Demand



Elasticity – the concept The responsiveness of one variable to

changes in another

When price rises, what happensto demand?

Demand falls

BUT

!ow m"ch does demand fall?



Elasticity – the concept#f price rises by $%& ' what happens to

demand?

We (now demand will fall

By more than $%&?

By less than $%&?

Elasticity measures the extent towhich demand will change



Elasticity) basic types "sed*Price elasticity of demand

Price elasticity of supply

Income elasticity of demandCross elasticity



ElasticityPrice Elasticity of Demand The responsiveness of demand

to changes in priceWhere & change in demand

is greater than & change in price – elasticWhere & change in demand is less than &

change in price ' inelastic



ElasticityPrice ($)

Quantity Demanded

The demand curve can be arange of shapes each of whichis associated with a differentrelationship between price andthe quantity demanded.



Elasticity

The ormula!

Ped "# hange in Quantity Demanded %%%%%%%%%%%%%%%%%%%%%%%%%%%

# hange in Price

&f answer is between ' and ! the relationship is inelastic

&f the answer is between and infinity! the relationship is elastic

*ote! P+D has , sign in front of it- because as price risesdemand falls and viceversa (inverse relationship betweenprice and demand)



Elasticity

Price

Quantity Demanded ('''s)

D

The importance of elasticityis the information itprovides on the effect ontotal revenue of changes inprice.

$

''

Total revenue is price /quantity sold. &n thise/ample0 T1 " 2 / ''0'''" 2''0'''.

This value is represented bythe grey shaded rectangle.

Total 1evenue



+lasticityPrice

Quantity Demanded ('''s)

D

&f the firm decides todecrease price to (say) 230the degree of price elasticityof the demand curve woulddetermine the e/tent of theincrease in demand and thechange therefore in total

revenue.$

''

$3

4'

Total 1evenue



Elasticity

Price ($)

Quantity Demanded

'

D

5

# 6 Price " '#

# 6 Quantity Demanded " 78'#

Ped " '.4 (&nelastic)

Total 1evenue would fall

Producer decides to lower price to attract sales

*ot a good move9



Elasticity

Price ($)

Quantity Demanded

D

'

8'

Producer decides to reduce price to increase sales

:

# 6 in Price " 3'#

# 6 in Demand " 7 3''#

Ped " ' (+lastic)Total 1evenue rises

;ood <ove9



The +eaning of Price Elasticityof demand

Demand* strong response to a change in

lastic demand* proportional response to ae -total amo"nt spent by cons"mers remainnged.

tic demand * wea( response to a price cha



ElasticityIf demand is

price elastic:#ncreasing price

wo"ld reduce T/

-&0 1d 2 & 0 P./ed"cing price

wo"ld increase T/

-&0 1d 2 & 0 P.

If demand isprice inelastic:#ncreasing price

wo"ld increase T/

-&0 1d 3 & 0 P./ed"cing price

wo"ld reduce T/-&0 1d 3 & 0 P.



Total 4"tlay +ethod Total 4"tlay is a

way to calc"latethe price elasticityof demand method

by loo(ing at thee5ect of changesin price on thereven"e earned by

the prod"cer6

#f price andreven"e move inthe same direction,demand is

inelastic6#f price and

reven"e move inthe opposite

direction, demandis elastic

#f reven"e remains"nchanged inresponse to a price



Elasticity and Total 4"tlays



Total 4"tlay +ethod and slope ofa demand c"rve

7oo( at Pg 89Perfectly elastic Demand is where cons"mers

are willing to pay any price in order toobtain a given :"antity of a good or

service6 The sit"ation can be representedby a hori;ontal demand c"rve6

n apple grower sells apples, along withmany other apple growers , at a fr"it andvegetable mar(et6 The grower can sell theentire load at the going mar(et price6 #f thegrower tries to sell the apples at a priceabove the going rate he will sell none6



Perfectly #nelastic demand is wherecons"mers are willing to pay any price inorder to obtain a give :"antity of a good orservice6 This sit"ation can be represented

by a vertical demand c"rve6 E<ample aperson with a life threatening illness wo"ldbe willing to pay almost anything6



/eview 1"estion$ and = pg 8>



actors a5ecting elasticity ofdemand

Whether the good is a l"<"ry or a necessity6'necessities have relative inelastic demand'

even if there is an increase in price, the:"antity demanded will not fall to a great

e<tent

'price elasticity of demand is higher forprod"cts that are regarded as l"<"ries




Whether the good has any closes"bstit"tes6

@oods with close s"bstit"tes tend to havehighly elastic demand6

#f the price increases the demand is is li(elyto contract more then proportionately6

@oods and Aervices with few or no closes"bstit"tes , s"ch as water s"pply, wo"ldhave inelastic demand' even if priceincrease, people cannot switch to anotherprod"ct




The e<pendit"re on the prod"ct as aproportion of income

#tems which ta(e "p a very small proportionof a persons income wo"ld have a lower

price elasticity of demand, whereas thedemand for more e<pensive items wo"ldtend to be more elastic6




The length of time s"bse:"ent to a pricechange

#f the price falls may ta(e time to becomeaware and adC"st to the price change

#f it increases, cons"mers may ta(e time tosee( o"t alternatives and s"bstit"teprod"cts




Whether a good is habit forming -addictive.or not

/elative inelastic demand6

E6@ Price rise in lcho'pops and cigarettesdid not lead to a large decrease in demand6

/E#EW 1UEAT#4 $'F pg 8G

Hhapter /eview pg 8I

price elasticity of demand

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