Chapter 18: Elasticity Price elasticity –demand –supply Cross elasticity Income elasticity Price…
Chapter 4 DEMAND ELASTICITY. The Concept of Elasticity In general, elasticity refers to percentage...
-
Upload
kory-wilcox -
Category
Documents
-
view
216 -
download
2
Transcript of Chapter 4 DEMAND ELASTICITY. The Concept of Elasticity In general, elasticity refers to percentage...
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 TR↓ TR⌐ TR↑
• Price decrease TR↑ TR⌐ TR↓
• Draw figures here
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: -0.55Explain 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?