1 Managerial Economics Demand Analysis The Concept of Elasticity and its Applications Ch. 3.
The Concept of Elasticity
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Transcript of The Concept of Elasticity
![Page 1: The Concept of Elasticity](https://reader030.fdocuments.in/reader030/viewer/2022032806/5681349b550346895d9b92a6/html5/thumbnails/1.jpg)
The Concept of Elasticity
![Page 2: The Concept of Elasticity](https://reader030.fdocuments.in/reader030/viewer/2022032806/5681349b550346895d9b92a6/html5/thumbnails/2.jpg)
Elasticity
What is the concept and why do we need it?
Elasticity is used to measure the effects of changes in economic variables
![Page 3: The Concept of Elasticity](https://reader030.fdocuments.in/reader030/viewer/2022032806/5681349b550346895d9b92a6/html5/thumbnails/3.jpg)
The Most Important Elasticity
• Price elasticity of demand
• A measure of the responsiveness of the quantity demanded of a good to a change in its price.
![Page 4: The Concept of Elasticity](https://reader030.fdocuments.in/reader030/viewer/2022032806/5681349b550346895d9b92a6/html5/thumbnails/4.jpg)
Demand: Gallons vs Litres Price($/g) Quant(g) Price($/L) Quant(L)
a 100 0 a' 25 0
b 50 25 b' 12.50 100
c 0 50 e' 0 200
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Elasticity: A Units-Free Measure
Price elasticity ofdemand =
Percentage change in quantity demanded
Percentage change in price
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Calculating Elasticity
P
Q
%
%
ave
ave
PP
/
/
Which is negative, but price elasticity ofdemand is given as a positive number
= (Q/P)(Pave/Qave)
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Calculating Elasticity
• Negative sign is ignored
• The changes in price and quantity are expressed as percentages of the average price and average quantity.
![Page 8: The Concept of Elasticity](https://reader030.fdocuments.in/reader030/viewer/2022032806/5681349b550346895d9b92a6/html5/thumbnails/8.jpg)
Quantity (millions of chips per year)
Pri
ce (d
olla
rs p
er c
hip)
36 40 44
390
400
410
Da
Originalpoint
Newpoint
Calculating the Elasticity of Demand
![Page 9: The Concept of Elasticity](https://reader030.fdocuments.in/reader030/viewer/2022032806/5681349b550346895d9b92a6/html5/thumbnails/9.jpg)
Quantity (millions of chips per year)
Pri
ce (d
olla
rs p
er c
hip)
36 40 44
390
400
410
Da
= $20P
= 8Q
Originalpoint
Newpoint
Calculating the Elasticity of Demand
![Page 10: The Concept of Elasticity](https://reader030.fdocuments.in/reader030/viewer/2022032806/5681349b550346895d9b92a6/html5/thumbnails/10.jpg)
Quantity (millions of chips per year)
Pri
ce (d
olla
rs p
er c
hip)
36 40 44
390
400
410
Da
Originalpoint
Newpoint
Pave = $400
= $20P
= 8Q
![Page 11: The Concept of Elasticity](https://reader030.fdocuments.in/reader030/viewer/2022032806/5681349b550346895d9b92a6/html5/thumbnails/11.jpg)
Quantity (millions of chips per year)
Pri
ce (d
olla
rs p
er c
hip)
36 40 44
390
400
410
Da
Originalpoint
Newpoint
Pave = $400
Qave = 40
= $20P
= 8Q
Calculating the Elasticity of Demand
![Page 12: The Concept of Elasticity](https://reader030.fdocuments.in/reader030/viewer/2022032806/5681349b550346895d9b92a6/html5/thumbnails/12.jpg)
Calculating Elasticity
PavePQaveQ
//
400/2040/8 = 4
meaning, on average, each 1% price decreaseCauses a 4% increase inquantity demanded
Price elasticity
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Some Interesting Characteristicsof
Linear Demand Curves(It is a straight Line)
Can be Deduced
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Compute Elasticity for Gasoline (in Gallons) from Earlier Example
0 25 50 100 200
25
100
Pri
ce (
$/un
it)
Quant. (G)
Gallons: slope = -2
When:Price falls from $100/gal to $0/gal
50
|P/Q| = 100/50 = 2
Pavg = 100/2 (=50)Qavg = 50/2 (=25)Pavg/ Qavg = (100/2)/(50/2)
= 2
![Page 15: The Concept of Elasticity](https://reader030.fdocuments.in/reader030/viewer/2022032806/5681349b550346895d9b92a6/html5/thumbnails/15.jpg)
|P/Q| = 100/50 = 2
Pavg/ Qavg = (100/2)/(50/2)= 2
The ratio of midpoint Price and Quantity = The slope
But for elasticity we want |Q/P|, the reciprocal of demand curve slope
|Q/P| = 1/2
Elasticity = |Q/P| (Pavg/ Qavg) = (1/2)*2 =1
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A Lesson: Elasticity on linear demand curves
0 25 50 100 200
25
100
Pri
ce (
$/un
it)
Quant. (G or L)
50 Elasticity = 1
For any Price-Quantity combinationElasticity > 1
Elasticity < 1
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Three types of price elasticity of demand
• inelastic
• Unit elastic
• elastic
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Inelastic Demand
• Inelastic demand
• The percentage change in quantity is less than the percentage change in price.
• Price elasticity of demand < 1
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Extreme Case: Perfectly Inelastic Demand
6
12
Pri
ce
Quantity
D1Elasticity = 0 WHY?
(Q/P)(Pave/Qave) =
(0/P)(Pave/Qave) = 0
Because Q = 0
![Page 20: The Concept of Elasticity](https://reader030.fdocuments.in/reader030/viewer/2022032806/5681349b550346895d9b92a6/html5/thumbnails/20.jpg)
Elastic Demand
• Elastic demand
• The percentage change in quantity is greater than the percentage change in price.
• Price elasticity of demand > 1
![Page 21: The Concept of Elasticity](https://reader030.fdocuments.in/reader030/viewer/2022032806/5681349b550346895d9b92a6/html5/thumbnails/21.jpg)
Extreme Case:Perfectly Elastic Demand
6
12
Pri
ce
Quantity
D3
Elasticity =
(Q/P)(Pave/Qave) =
Because P = 0
(Q/0)(Pave/Qave) =
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Unit Elastic Demand
• Unit elasticity
• The percentage change in quantity equals the percentage change in price.
• Price elasticity of demand = 1
![Page 23: The Concept of Elasticity](https://reader030.fdocuments.in/reader030/viewer/2022032806/5681349b550346895d9b92a6/html5/thumbnails/23.jpg)
Extreme Case:Unit Elastic Demand Everywhere
6
12
Pri
ce
Quantity
D2
1 2 3
Elasticity = 1
Unit Elasticity
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Factors That Influence Elasticity
• The Closeness of Substitutes.
• The closer the substitutes, the more elastic the demand
•more elastic means a higher price elasticity (but not necessarily > 1)
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Elasticity and Closeness of Substitutes
Quantity (pounds per week)
Pri
ce (d
olla
rs p
er p
ound
)
5
10
No close subs
1 2 3 4 7
Orange Roughy
Close subs
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Factors That Influence Elasticity
• Proportion of Income Spent on the Good
• The greater the proportion of income spent on food, the more elastic the demand•Because of Income Effect of a price change
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Factors That Influence Elasticity
• Time Elapsed Since Price Change
• The longer the time, the more elastic the demand•Short-run demand•Long-run demand
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Factors Affecting Price Elasticity of Demand
• Availability of substitutes
• The better & more numerous the substitutes for a good, the more elastic is demand
• Percentage of consumer’s budget
• The greater the percentage of the consumer’s budget spent on the good, the more elastic is demand
• Time period of adjustment
• The longer the time period consumers have to adjust to price changes, the more elastic is demand
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Income Elasticity
• Income elasticity (EM) measures the
responsiveness of quantity demanded to changes in income, holding the price of the good & all other demand determinants constant
• Positive for a normal good
• Negative for an inferior goodd dM
d
% Q Q ME
% M M Q
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Cross-Price Elasticity
• Cross-price elasticity (EXY) measures the
responsiveness of quantity demanded of good X to changes in the price of related good Y, holding the price of good X & all other demand determinants for good X constant
• Positive when the two goods are substitutes
• Negative when the two goods are complementsX X Y
XYY Y X
% Q Q PE
% P P Q