elasticity

(1)

Elasticity

(2)

Price Elasticity of Demand

•

Measures the responsiveness of the quantity

demanded of a good to a change in price.

Who uses PED

•

Suppliers

–

will decreasing/increasing price

cause a change in QD

•

Government & Minister of Finance

–

VAT &

Excise Duties

•

Monopolist

–

see how far they can raise prices

see how

far they can raise prices

until they become elastic.

(3)

PED Formula

( - Negative) = Goods which obey ( - Negative) = Goods which obey Law of Demand = Normal Goods Law of Demand = Normal Goods

( +

( + Positive) = Positive) = Goods which Goods which don’tdon’t

obey Law of Demand obey Law of Demand

--

∞

_-1

0

Perfectly elastic

(4)

P P Q Q D D D D P P Q Q

(5)

Q Q P P D D Q Q P P D D

(6)

Inelastic Demand: The percentage change in demand is less

than the percentage change in price

Q Q P P D D

(7)

Factors that Effect PED

(8)

(9)

2004 HL

(10)

2004 HL

(11)

2004 HL

(12)

2010 (B)

(13)

Income Elasticity of Demand (YED)

= measures the

responsiveness of Quantity demanded to a change in

Income

0

Inelastic/ Necessity

11

Elastic / Luxury

Inferior Goods =

(- Negative)

Normal Goods =

Normal Goods = PositivePositive

Inferior Goods (- Negative)

Inferior Goods (- Negative) – – _{the demand for these goods fall when Income}_{the demand for these goods fall when Income}

Rises e.g.

Rises e.g. Tesco ValueTesco Value

Normal Goods (Positive +)

Normal Goods (Positive +) – – _{the demand for these goods Increases when}_{the demand for these goods Increases when}

Income Rises e.g.

(14)

YED Formula

• •

∆

∆

×

1+2

1+2

(15)

YED Calculation 2009

•

• As the Goods are Positive this means they are Normal = If Income Falls , QD will FallAs the Goods are Positive this means they are Normal = If Income Falls , QD will Fall

•

• The good has a YED of 2.5 which is greater than 1 which means it is Elastic.The good has a YED of 2.5 which is greater than 1 which means it is Elastic.

•

• Therefore If Income fell by 1% , QD would fall 2.5 times that amount.Therefore If Income fell by 1% , QD would fall 2.5 times that amount.

•

• We We can see income fell by 8% can see income fell by 8% therefore , therefore , QD would fall 2.5 times that amount QD would fall 2.5 times that amount == 20%

20% •

• Sales were 100,000 and have Sales were 100,000 and have fallen by 20% fallen by 20% = 20,000= 20,000

•

(16)

Cross Elasticity of Demand

= measures the

responsiveness of the Quantity demanded of one good

to change in price of another good

• •

∆ 

∆  

×

 1 +2  

 1 +2  

Negative = Complements

Negative = Complements Positive= SubstitutesPositive= Substitutes

0

0 Complements

Complements

= goods sold together e.g.

= goods sold together e.g. IPods & Earphones

IPods & Earphones

Substitutes

= goods

= goods that act as alternatives for each other e.g. Pepsi

that act as alternatives for each other e.g. Pepsi

& Coke

(17)

Cross Elasticity of Demand

•

Positive

= Substitutes e.g. If the Price of tea rises , then the

quantity demanded of

quantity demanded of coff

coffee rises

ee rises as consumers substitute to

as consumers substitute to

now relatively cheaper

now relatively cheaper coff

coffee.

ee.

•

NB The Bigger the Number the Closer the Substitute.

•

Negative

= Complements, Negative relationship between

the price of good a and good B, e.g. if the price of shoes rise,

the quantity

the quantity demanded of

demanded of shoelaces

shoelaces will f

will fall.

all.

•

NB The Bigger the Negative Number the C

NB The Bigger the Negative Number the Closer the

loser the

Complement.

•

Result of ZERO = No Relationship e.g. price of

Coffee and QD of potatoes

(18)

Cross Elasticity of Demand

(19)

CW:

A consumer buys 10 units of Good

A consumer buys 10 units of Good A when the

A when the

price of Good B is

€

5.

5. When the price of Good B rises to

When the price of Good B rises to

€

6 (the price of

Good A remaining unchanged) the consumer buys

14 units of Good A.

(i)

Define cross elasticity of demand.

(ii)

Using an appropriate formula, calculate this

consumer’s cross elasticity of demand for

Good A.

Show your workings.

(iii)

Is Good A a substitute for, or a complement to,

Good B? Explain

(20)

Price Elasticity of Supply

•

• PES measures the responsiveness of Quantity Supplied to a changePES measures the responsiveness of Quantity Supplied to a change

in price. in price. • • FormulaFormula 2 Results either 2 Results either •

• PositivePositive = as Price = as Price rises QS will Rise (max revenue) or as price fallsrises QS will Rise (max revenue) or as price falls

QS will fall (switch to other goods) QS will fall (switch to other goods)

Large No. = very

Large No. = very responsive to a price change (Elastic)responsive to a price change (Elastic) Small No. = not

Small No. = not very responsive tvery responsive to a price changeo a price change (Inelastic)

(Inelastic)

•

• Zero = producer cannot or does not respond to a price change. HereZero = producer cannot or does not respond to a price change. Here

Supply =

Supply = Perfectly InelasticPerfectly Inelastic

• •

∆ 

∆

×

 1+ 2

 1+ 2

(21)

Factors effecting PES

1.

1. CapCapaciacity ty of of the the supsuppliplierer – – if the firm is operating at full capacity, then it if the firm is operating at full capacity, then it may not be able to increase supply in response to the price rise. In this may not be able to increase supply in response to the price rise. In this case, supply would be inelastic

case, supply would be inelastic 2.

2. LeLengngth th of of titimeme – – A farmer producing potatoes and carrots could take a A farmer producing potatoes and carrots could take a full year to respond. If the price of carrots rises it will take the farmer a full year to respond. If the price of carrots rises it will take the farmer a year to reallocate potato fields to carrots

year to reallocate potato fields to carrots – – the longer the length of the longer the length of time to respond the more elastic the supply.

time to respond the more elastic the supply. 3.

3. NaNatuture ore of thf the pre prododucuctt – – e.g. a fisherman may have a catch of fish to e.g. a fisherman may have a catch of fish to sell. If the price of

sell. If the price of fish falls he or she will still wish to supply the fish,fish falls he or she will still wish to supply the fish, even at a lower price as the product is perishable. Perishable products even at a lower price as the product is perishable. Perishable products will therefore have an inelastic supply.

will therefore have an inelastic supply. 4.

4. MobiMobility lity of fof factactors ors of of ProProductiductionon – – the supplier can easily switch his or the supplier can easily switch his or her resources towards supplying the good which has gone up in price, her resources towards supplying the good which has gone up in price, then supply is elastic.

then supply is elastic. 5.

5. Factors outside the firm’s control – Factors outside the firm’s control – _{If there is a strike by staff or a}_{If there is a strike by staff or a}

disruption in the supply of raw materials or a

disruption in the supply of raw materials or a bad harvest in farming,bad harvest in farming, there is little a supplier can do to increase supply in response to a price there is little a supplier can do to increase supply in response to a price

(22)

2007 SQ

(23)

2006

(24)

2006

(25)

2003 2003

(26)

2003 2003