Elasticity of demand
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Elasticity of demand
Elasticity of demand What elasticity measures? How the price elasticity formula is applied
to measure the elasticity of demand? The difference between elastic, inelastic
and unitary elastic demand? How total revenue varies in each of these
tree cases? The meaning of perfect elasticity and
perfect inellasticity
Price elasticity of demand
is a measure of the sensitivity of quantity demanded to chages in the price of a product
When quantity demanded is relatively sensitive (insensitive) to a price change demand is said to be elastic (inelastic)
Degree of elasticityThe exact degree of elasticity can be
measured by using a formula to compute the elasticity coefficient:
where:D – percentage change in demand: (yt-yt-1)/yt-1P – percentage change in prices: (xt-xt-1)/xt-1
PDEC
How to estimate price elasticity
P - price D - demand ∆P ∆D Ep
2,5 80
5 60 100% -25% -0,25
7,5 40 50% -33% -0,67
10 20 33% -50% -1,50
It is important to note that the elasticity of demand is not the same at all prices and that demand is typically elastic at higher and inelastic at lower prices
Elastic, inelastic and unit elastic demand
Demand is elastic (inelastic, unit elastic) when the percentage change in quantity is greater then (less then, equal
to) the percentage change in price and the elasticity coefficient is greater than (less
than, equal to) 1
The sign of elasticity coeficientBecause price and quantity demanded are inversely related to each other the price elasticity of demand coefficient is a negative number – but economists ignore the minus sign in front of the coefficient and focus their attention on its absolute value
The price elasticity of demand for a product depends upon the number of good subsitutes the
product has its relative importance in the
consumer’s budget whether it is a necessity or luxury
Relation between price elasticity and revenue
The way in which total revenue changes (increases, decreases, or remains constant) when price changes is a test of the elasticity of demand for a productFor elastic demand Ep(- ∞ ;-1): when price decreases (increases) then revenues increases (decreases)For inelastic demand Ep(- 1 ; 0): when price decreases (increases) then revenues decreases (increases)For unit elastic demand Ep=-1: the revenues are maximum
The example of the previous rule
P – price in £
D-demand in tho.of units
∆P ∆D Ep Revenues in tho. of £
2,50 80 -100% 25% -0,25 200
5,00 60 -10% 7% -0,67 300
5,50 56 -9% 7% -0,79 308
6,00 52 -4% 4% -0,92 312
6,25 50 -12% 12% -1,00 312,5
7,00 44 -7% 9% -1,27 308
7,50 40 -33% 50% -1,50 300
10,00 20
Fill-in questions 1 To find out that the demand is elastic
you must know (price elasticity of demand, income elasticity of demand)……………...
Fill-in questions 2 If a relatively large change in price results
in a relatively small change in demand, demand is (elastic/ineclastic/perfect eleasit)…………………………….
If a relatively small change in price results in a relatively large change in demand, demand is (elastic/ineclastic/perfect eleastic)…………………………..
Fill-in questions 3 If a change in price causes no change in
demand, demand is perfectly (elastic, inelastic)…………………...and the demand curve is (perpendicular to any axis, slopes down in the rights)…………………
If an extremely small change in price results in an extremely large change in demand, demand is (perfectly elastic/perfectly inelastic)
Fill-in questions 4If the price of a commodity declineswhen demand is inelastic the loss of revenue due to the lower price is (greater than, less then, equal to) …………………….the gain in revenue due to the greater quantity demandedwhen demand is elastic the loss of revenue due to the lower price is (greater than, less then, equal to) …………………….the gain in revenue due to the greater quantity demandedwhen demand is inelastic the loss of revenue due to the lower price is (greater than, less then, equal to) …………………….the gain in revenue due to the greater quantity demanded
Fill-in questions 5 If demand is elastic, price and total
revenue are (directly, inversely) …….…… related
If demand is inelastic, price and total revenue are (directly, inversely) …….…… related
Fill-in questions 6Complete the summary table below
If demand is:
The elasticity coefficient is
If price rises, total revenue
will
If price falls, total revenue
will
Elastic
Inelastic
Of unitary elasticity
Fill-in questions 6Which of below determinants are not the determinants of the elasticity of demand:1.The number of good substitute products2.The relative importance of the product in the total budged of the buyer3.Whether the good is a necessity or a luxury
Fill-in questions 7If the demand schedules for a certain product are those given in the table, answer the following questions.
Price in $ Demand in units10 129 138 147 156 165 174 18
• What is price elasticity of demand for price P=6$...........................
• If we reduct price to 5$, revenus will (decrease/increase)………• What is the „best” price for this product……………………………..
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