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7/18/2019 Price Elasticity of Demand
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Price Elasticity of Demand
7/18/2019 Price Elasticity of Demand
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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?
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Elasticity – the concept#f price rises by $%& ' what happens to
demand?
We (now demand will fall
By more than $%&?
By less than $%&?
Elasticity measures the extent towhich demand will change
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Elasticity) basic types "sed*Price elasticity of demand
Price elasticity of supply
Income elasticity of demandCross elasticity
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ElasticityPrice Elasticity of Demand The responsiveness of demand
to changes in priceWhere & change in demand
is greater than & change in price – elasticWhere & change in demand is less than &
change in price ' inelastic
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ElasticityPrice ($)
Quantity Demanded
The demand curve can be arange of shapes each of whichis associated with a differentrelationship between price andthe quantity demanded.
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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)
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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
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+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.$
''
$3
4'
Total 1evenue
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Elasticity
Price ($)
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
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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
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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
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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.
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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
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Elasticity and Total 4"tlays
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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
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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
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/eview 1"estion$ and = pg 8>
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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
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actors a5ecting elasticity ofdemand
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
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actors a5ecting elasticity ofdemand
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
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actors a5ecting elasticity ofdemand
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
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actors a5ecting elasticity ofdemand
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