Economic Analysis Economic Analysis for Business for Business Session V: Elasticity and Session V: Elasticity and its Application-1 its Application-1 Instructor Instructor Sandeep Basnyat Sandeep Basnyat 9841892281 9841892281 [email protected][email protected]
45
Embed
Economic Analysis for Business Session V: Elasticity and its Application-1
Economic Analysis for Business Session V: Elasticity and its Application-1. Instructor Sandeep Basnyat 9841892281 [email protected]. 0. A scenario…. You design websites for local businesses. You charge $200 per website, and currently sell 12 websites per month. - PowerPoint PPT Presentation
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Economic Analysis Economic Analysis for Businessfor Business
Session V: Elasticity and its Session V: Elasticity and its Application-1Application-1
You design websites for local businesses. You charge $200 per website, and currently sell 12 websites per month. Your costs are rising (including the opp. cost of your time), so you’re thinking of raising the price to $250. The law of demand says that you won’t sell as many websites if you raise your price. How many fewer websites? How much will your revenue fall, or might it increase?
You design websites for local businesses. You charge $200 per website, and currently sell 12 websites per month. Your costs are rising (including the opp. cost of your time), so you’re thinking of raising the price to $250. The law of demand says that you won’t sell as many websites if you raise your price. How many fewer websites? How much will your revenue fall, or might it increase?
A scenario…A scenario…
CHAPTER 5 ELASTICITY AND ITS APPLICATION
ElasticityElasticityBasic idea: Elasticity measures how
much one variable responds to changes in another variable. ◦One type of elasticity measures how much
demand for your websites will fall if you raise your price.
Definition: Elasticity is a numerical measure of the responsiveness of Qd or Qs to one of its determinants.
Elastic and Inelastic demand and supply.
CHAPTER 5 ELASTICITY AND ITS APPLICATION
Price Elasticity of DemandPrice Elasticity of Demand
Price elasticity of demand measures how much Qd responds to a change in P.
Price elasticity of demand
=Percentage change in Qd
Percentage change in P
Loosely speaking, it measures the price-sensitivity of buyers’ demand.
CHAPTER 5 ELASTICITY AND ITS APPLICATION
Price Elasticity of DemandPrice Elasticity of Demand
Price elasticity of demand equals
P
Q
D
Q2
P2
P1
Q1
P rises by 10%
Q falls by 15%
15%
10%= 1.5
Price elasticity of demand
=Percentage change in Qd
Percentage change in P
Example:
CHAPTER 5 ELASTICITY AND ITS APPLICATION
Price Elasticity of DemandPrice Elasticity of Demand
Calculate the slope of the Demand and Supply curves
• To find the slope of the demand curve, pick any two points (quantity demanded) on it and their corresponding prices.
• For example, pick points 8 on quantity demanded and it’s corresponding price $0.80. So, the first coordinate is (8, 0.80).
• Similarly, pick another coordinates as (12, 0.40). • Using the slope formula, Slope of the demand curve is:
(12-8)/(0.40−0.80) = 4/- 0.40 = -10Find the slope of the supply curve !!
AnswAnswerer
Calculating Price Elasticity of Calculating Price Elasticity of DemandDemandThe estimated linear demand function
for pork is:Q = 286 -20p
◦ where Q is the quantity of pork demanded in million kg per year and p is the price of pork in $ per year.
◦ At the equilibrium point of p = $3.30 and Q = 220 Find the elasticity of demand for pork:
Calculating Price Elasticity of Calculating Price Elasticity of DemandDemandThe estimated linear demand function
for pork is:Q = 286 -20p
◦ where Q is the quantity of pork demanded in million kg per year and p is the price of pork in $ per year.
◦ At the equilibrium point of p = $3.30 and Q = 220 the elasticity of demand for pork:
3.0220
30.320
Q
pb
Numerical exampleNumerical example
Consider a competitive market for which the quantities demanded and supplied (per year) at various prices are given as follows:Price($) Demand (millions) Supply (millions)
60 22 1480 20 16100 18 18120 16 20
Calculate the price elasticity of demand when the price is $80. When the price is $100.
Solution to Numerical exampleSolution to Numerical example
.P
Q
Q
P
P
PQ
Q
E D
D
D
D
D
From the above question, with each price increase of $20, the quantity demanded decreases by 2. Therefore,
QD
P
2
20 0.1.
At P = 80, quantity demanded equals 20 and
ED 80
20
0.1 0.40.
Similarly, at P = 100, quantity demanded equals 18 and
ED 100
18
0.1 0.56.
Some more questionsSome more questionsWhat are the equilibrium price and
quantity?
Suppose the government sets a price ceiling of $80. Will there be a shortage, and, if so, how large will it be?
Some more questionsSome more questionsWhat are the equilibrium price and
quantity?Equilibrium price is $100 and the equilibrium quantity is 18 million.
Suppose the government sets a price ceiling of $80. Will there be a shortage, and, if so, how large will it be?With a price ceiling of $80, consumers would like to buy 20 million, but producers will supply only 16 million. This will result in a shortage of 4 million.
Non-linear demand function-Numerical Non-linear demand function-Numerical ExampleExampleConsider the following non-linear demand
function:Q = Pα
If the value of α = -2, is the demand Price elastic or inelastic?
Non-linear demand function-Numerical Non-linear demand function-Numerical ExampleExampleConsider the following non-linear demand
function:Q = Pα
If the value of α = -2, is the demand Price elastic or inelastic?
““Perfectly elastic demand”Perfectly elastic demand” (the other (the other extreme)extreme)
P
Q
P1
Q1
P changes by 0%
Q changes by any %
any %
0%= infinity
Q2
P2 =Consumers’ price sensitivity:
D curve:
Elasticity:infinity
horizontal
extreme
Price elasticity
of demand
=% change in Q
% change in P=
CHAPTER 5 ELASTICITY AND ITS APPLICATION
Elasticity of a Linear Demand Elasticity of a Linear Demand CurveCurve
The slope
of a linear demand curve is constant, but its elasticity is not.
P
Q
$30
20
10
$00 20 40 60
200%40%
= 5.0E =
67%67%
= 1.0E =
40%200%
= 0.2E =
CHAPTER 5 ELASTICITY AND ITS APPLICATION
Price Elasticity and Total Price Elasticity and Total RevenueRevenueContinuing our scenario, if you raise your price
from $200 to $250, would your revenue rise or fall?
Revenue = P x Q A price increase has two effects on revenue:
◦Higher P means more revenue on each unit you sell.
◦But you sell fewer units (lower Q), due to Law of Demand.
Which of these two effects is bigger? It depends on the price elasticity of demand.
CHAPTER 5 ELASTICITY AND ITS APPLICATION
Price Elasticity and Total Price Elasticity and Total RevenueRevenue
If demand is elastic, then price elast. of demand > 1 % change in Q > % change in P
The fall in revenue from lower Q is greater than the increase in revenue from higher P, so revenue falls.
Revenue = P x Q
Price elasticity of demand
=Percentage change in Q
Percentage change in P
CHAPTER 5 ELASTICITY AND ITS APPLICATION
Price Elasticity and Total Price Elasticity and Total RevenueRevenue
Elastic demand(elasticity = 1.8) P
Q
D$200
12
If P = $200, Q = 12 and revenue = $2400.
When D is elastic, a price increase causes revenue to fall.
$250
8
If P = $250, Q = 8 and revenue = $2000.
lost revenue due to lower Q
increased revenue due to higher P
Demand for your websites
CHAPTER 5 ELASTICITY AND ITS APPLICATION
Price Elasticity and Total Price Elasticity and Total RevenueRevenue
If demand is inelastic, then price elast. of demand < 1 % change in Q < % change in P
The fall in revenue from lower Q is smaller than the increase in revenue from higher P, so revenue rises.
In our example, suppose that Q only falls to 10 (instead of 8) when you raise your price to $250.
Revenue = P x Q
Price elasticity of demand
=Percentage change in Q
Percentage change in P
CHAPTER 5 ELASTICITY AND ITS APPLICATION
Price Elasticity and Total Price Elasticity and Total RevenueRevenue
Now, demand is inelastic: elasticity = 0.82
P
Q
D
$200
12
If P = $200, Q = 12 and revenue = $2400. $250
10
If P = $250, Q = 10 and revenue = $2500.When D is inelastic, a price increase causes revenue to rise.
lost revenue due to lower Q
increased revenue due to higher P
Demand for your websites
AA CC TT II VV E LE L EE AA RR NN II NN G G 22: : Elasticity and expenditure/revenueElasticity and expenditure/revenue
A. Pharmacies raise the price of insulin by 10%. Does total expenditure on insulin rise or fall?
B. As a result of a fare war, the price of a luxury cruise falls 20%. Does luxury cruise companies’ total revenue rise or fall?
42
AA CC TT II VV E LE L EE AA RR NN II NN G G 22: : AnswersAnswers
43
A. Pharmacies raise the price of insulin by 10%. Does total expenditure on insulin rise or fall? Expenditure = P x Q Since demand is inelastic, Q will fall less than 10%, so expenditure rises.
AA CC TT II VV E LE L EE AA RR NN II NN G G 22: : AnswersAnswers
44
B. As a result of a fare war, the price of a luxury cruise falls 20%. Does luxury cruise companies’ total revenue rise or fall? Revenue = P x Q
The fall in P reduces revenue, but Q increases, which increases revenue. Which effect is bigger?
Since demand is elastic, Q will increase more than 20%, so revenue rises.