IFIM Elasticity
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Transcript of IFIM Elasticity
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The price el ast icity of dem an d an d its de termi nants
Dem an d tends to be more el ast ic (inelast ic):
th e la rger (Fewer ) th e number of clo se sub st itutes if th e good i s a luxur y (nece ss ity) th e more na rrowl y(bro ad) defi ned th e m arke t th e long er ( sh or ter ) th e t ime period
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Compu t ing th e price el ast icity of dem an d
The price el ast icity of dem an d is compu ted as th eperce ntag e chang e in th e qu ant ity dem an deddivided b y th e perce ntag e c hang e in price.
E d =% change in quantity demanded
% change in price
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Compu t ing th e price el ast icity of dem an d(poi nt elast icity)
Example : If th e price of an ice cre am co neincre as es from $2.00 to $2.20 an d th e amou nt you bu y f a lls from 10 to 8 co nes, th en your
elast icity of dem an d would be c a lculat ed as (ignoring the negative sign ):
( )
( . . ).
.
10 88 100
220 200220
100
25%9%
27v
v
! !
75.2
275.010820.2
20.02
!
v!
v!
v(
(
Q P
P Q
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The Arc el ast icity me th od
The arc elasticity formula is prefer ablewhen ca lculat ing th e price el ast icity of dem an d bec ause it gives th e sa means wer re ga rdle ss of th e direc t ion of th echang e.
P rice elasticity of demand =
v
((
Q p
P Q
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Ca lculat e u sing th e arc elast icity me th od
Example : If th e price of an ice cre am co neincre as es from $2.00 to $2.20 an d th eamou nt you bu y f a lls from 10 to 8 co nes, th en your el ast icity of dem an d , using th e arcelast icity formul a, would be c a lculat ed as (ignoring the negative sign ):
3.22
3.010
1820.4
20.02
!
v
!v
7
7v(
(
Q P
P Q
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Inelastic demand Q uant ity dem an ded doe s not re spo nd
st rong ly to price c hang es. Price el ast icity of dem an d is less than one.
E lastic demand Q uant ity dem an ded re spo nds st rong ly to
chang es in price. Price el ast icity of dem an d is great er than
one.
Inelastic demand Q uant ity dem an ded doe s not re spo nd
st rong ly to price c hang es. Price el ast icity of dem an d is less than one.
E lastic demand Q uant ity dem an ded re spo nds st rong ly to
chang es in price. Price el ast icity of dem an d is great er than
one.
The variety of demand curves
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The varie ty of dem an d curve sPerfectly inelastic Q uant ity dem an ded doe s not re spo nd to
price c hang es.
Perfectly elastic Q uant ity dem an ded c hang es infin itely with
any chang e in price.
nit elastic Q uant ity dem an ded c hang es by th e sa meperce ntag e as th e price.
Perfectly inelastic Q uant ity dem an ded doe s not re spo nd to
price c hang es.
Perfectly elastic Q uant ity dem an ded c hang es infin itely with
any chang e in price.
nit elastic Q uant ity dem an ded c hang es by th e sa meperce ntag e as th e price.
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Because th e price el ast icity of dem an dme as ure s how muc h qu ant ity dem an dedre spo nds to th e price , it is closely relat ed to
th e slope of th e dem an d curve.
The variety of demand curves
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(b) Inelastic demand: elasticity is less than 1
Quantity0
$5
90
Deman d1 . A 22%incre as ein price ...
Price
2. ... le ads to an 11 % decre as e in qu ant ity dem an ded.
4
100
The price el ast icity
of dem an d
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The price el ast icity
of dem an d
Cop yright2003 S o uthwestern/Th o ms o n Learning
2. ... le ads to a 22% decre as e in qu ant ity dem an ded.
(c) Unit elastic demand: elasticity equals 1
Quantity
4
1000
Price
$5
80
1 . A 22%incre as ein price ...
Deman d
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The price el ast icity
of dem an d(d) Elastic demand: elasticity is greater than 1
Deman d
Quantity
4
1000
Price
$5
50
1 . A 22%incre as ein price ...
2. ... le ads to a 67% decre as e in qu ant ity dem an ded.
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The price el ast icity
of dem an d(e) Perfectly elastic demand: elasticity equals infinity
Quantity0
Price
$4 Deman d
2. At exact ly $4 ,cons umer s willbu y any qu ant ity.
1 . At any priceabove $4 , qu ant ity
dem an ded i s zero.
3. At a price below $4 ,qu ant ity dem an ded i s in fin ite.
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Cop yright2003 S o uthwestern/Th o ms o n Learning
(a) Perfectly inelastic demand: elasticity equals 0
$5
4
Quantity
Deman d
1000
1 . Anincre as ein price ...
2. ... le aves th e qu ant ity dem an ded u nchang ed.
Price
The price el ast icity
of dem an d
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Tota l reve nue an d th e priceelast icity of dem an d
T otal revenue is th e amou nt pa id by bu yer s an d received b y seller s of a good.
Ca lculat ed as th e price of th e good t ime s th e qu ant ity sold.
TR= P x Q
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Tota l reve nue
Cop yright2003 S o uthwestern/Th o ms o n Learning
Deman d
Quantity
Q
P
0
Price
P Q = $400
(reve nue )
$4
100
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How tota l reve nue c hang es: inelast icdem an d
Cop yright2003 S o uthwestern/Th o ms o n Learning
Dem an d
Quantity0
Price
Reve nue = $100
Quantity0
Price
Revenue = $240
Dem an d$1
100
$3
80
An Increase in p rice fr o m $1to $3
leads t o an Increase in t o talrevenue fr o m $100 t o $240
With an inelast ic dem an d curve , an incre as e in price le ads to a decre as e in
qu ant ity that is propor t ionat ely sma ller. Thus, tota l reve nue incre as es.
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How tota l reve nue c hang es: elast icdem an d
Cop yright2003 S o uthwestern/Th o ms o n Learning
Dem an d
Quantity0
Price
Revenue = $200
$4
50
Dem an d
Quantity0
Price
PXQ =$5x 20Revenue = $100
$5
20
An Increase in p rice fr o m $4to $5
leads t o an decrease in t o talrevenue fr o m $200 t o $100
With an elast ic dem an d curve , an incre as e in th e price le ads to a decre as e in qu ant ity dem an ded that is propor t ionat ely larger. T hus, tota l reve nue decre as es.
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Income el ast icity of dem an d
Income elasticity of demand me as ure s howmuc h th e qu ant ity dem an ded of a goodre spo nds to a chang e in cons umer s income.It is ca lculat ed as th e perce ntag e chang e in th e qu ant ity dem an ded divided b y th eperce ntag e chang e in income.
% change in inc o me
Inco me elasticity o f Demand =
% change in quantity demanded
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Income el ast icity
Type s of good s N ormal good s ha ve po sit ive income
elast icity Inferior good s ha ve negat ive income
elast icity
H igh er income r a ises th e qu ant ity
dem an ded for norm a l good s bu t lower s th e qu ant ity dem an ded for i nferiorgood s.
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Income el ast icity
Good s cons umer s re ga rd as nece ss it ies tend to be i ncome i nelast ic.
Example s include food , fuel , cloth ing, ut ilit ies an d medic a l service s.
Good s cons umer s re ga rd as luxurie s tendto be i ncome el ast ic.
Example s include spor ts cars, furs, an dexpe ns ive food s.
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What is cross -elast icity of dem an d?
The rat io of th e perce ntag e c hang e in qu ant ity dem an ded of a good to a given perce ntag e c hang e in price of an oth er good :Cross elast icity ca lculat ions reve a l whe th er good s a resubstitutes or co mp lements in use.
Wh en your ans wer i s po sitive it me ans that a rise in th e price of let s say pe n will lead to an incre as e in th e qu ant ity dem an dedof pe ncil substitutes .Wh en your ans wer i s negative it me ans that a rise in th e price of let s say cars will lead to a decre as e in th e qu ant ity dem an ded of pe trol co mp lements.
% change in quantity demanded of good A% change in price of good B
Ed =
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The el ast icity of suppl y
Price elasticity of su pp ly is a me as ure of howmuc h th e qu ant ity supplied of a goodre spo nds to a chang e in th e price of that good.
E p of Suppl y = % change in quantity supplied% change in price
If E >1 th en th is reflec ts that th e qu ant ity supplied move s propor t ionat ely more than its price , suppl y is sa id to be El ast ic
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Determi nants of el ast icity of suppl y
Ability of seller s to chang e th e amou nt of th e good th ey produce.
Beach-front lan d is inelast ic. Ep < 1In th e above c as e p rice elasticity o f supp ly will
be less than 1 where the quantity su pp liedmo ves p ropo rti o nately less than the p rice.
Books, cars, or m an uf actured good s are el ast ic.
Time period. Supply is more el ast ic in th e long run .
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Elast icity an d tax incide nce
T ax incidence is th e m ann er in wh ich th eburde n of a tax is sha red amo ng pa rt icipants in a ma rke t .Tax incide nce is th e st ud y of who be a rs th e burde n of a tax .Taxes re sult in a chang e in ma rke t
equilibrium.Buyer s pay more an d seller s receive le ss, re ga rdle ss of whom th e tax is levied o n .
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Elast icity an d tax incide nce
What is th e imp act of tax ? Taxes discour ag e m a rke t act ivity. Wh en a good i s tax ed , th e qu ant ity sold is
sma ller. Buyer s an d seller s sha re th e tax burde n .
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A tax on bu yer s
Cop yright2003 S o uthwestern/Th o ms o n Learning
Quantity o f ice-cream c o nes
0
Price o f ice-creamco ne
Price
with ou ttax
Priceseller sreceive
Equilibrium wi th ou t taxTax ($0.50 )
Pricebu yers
pay
D1
D2
Suppl y, S1
A tax on bu yerssh if ts th e dem an dcurve dow nwardby th e size of th e tax ($0.50 ).
$3.30
90
Equilibriumwith tax
2.80
3.00
100
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A tax on seller s
Cop yright2003 S o uthwestern/Th o ms o n Learning
2.80
Quantity o f ice-cream c o nes
0
Price o f ice-cream
co ne
Price
with ou ttax
Priceseller sreceive
Equilibriumwith tax
Equilibrium wi th ou t tax
Tax ($0.50 )
Pricebu yer s
payS1
S2
Deman d, D1
A tax on seller ssh if ts th e suppl ycurve upw ardby th e amou nt of th e tax ($0.50 ).
3.00
100
$3.30
90
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Elast icity an d tax incide nce
In what propor t ions is th e burde n of th etax divided?H
ow do th e effec ts of tax es on seller s comp are to th ose levied o n bu yer s?The ans wer s to th ese que st ions depe ndon th e el ast icity of dem an d an d th eelast icity of suppl y.
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How th e burde n of a tax is divided
Cop yright2003 S o uthwestern/Th o ms o n Learning
Quantity0
Price
Deman d
Supply
Tax
Price seller sreceive
Price bu yer s pay
(a) Elastic su pp ly, inelastic demand
2. ... th eincide nce of th etax f a lls moreheavily oncons umer s ...
1. Wh en suppl y is more el ast icthan dem an d ...
Price wi th ou t tax
3. ... than on producer s.
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How th e burde n of a tax is divided
Cop yright2003 S o uthwestern/Th o ms o n Learning
Quantity0
Price
Dem an d
Supply
Tax
Price seller sreceive
Price bu yer s pay
(b) Inelastic su pp ly, elastic demand
3. ... than oncons umer s.
1. Wh en dem an d is more el ast icthan suppl y ...
Price wi th ou t tax
2. ... th eincide nce of th e tax f a lls more heavily on producer s ...
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Review que st ion
E conomists have observed that s pendingon restaurants meals declines moreduring economic recession than doess pending on food to be eaten at home .
How mi ght th e co ncep t of el ast icity helpto e xpla in th is phenome non?
AUT Faculty of Business & Law 20 10 38