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# Mic 4

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• ### Mic 4

3. 3. INTRODUCTION TO ELASTICITY Elasticity is an important concept as it is vital and applicable in the daily of households, lives businesses and researchers. Elasticity it is not limited to the concept of demand, supply and income elasticity but also to the concept of growth and development.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 4– 3
4. 4. DEFINITION TO ELASTICITY Elasticity measures the magnitude of responsiveness of any variable to a change in one of the determinant’s factors. For example, quantity demanded or supplied would change if price or income changes.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 4– 4
5. 5. FORMULA OF ELASTICITY • The value of elasticity can be measured by: Elasticity = Percentage change in Quantity Demanded Percentage change in Quantity SuppliedMicroeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 4– 5
6. 6. APPLICATION OF ELASTICITY Policy makers, producers and consumers use elasticity in their daily decision making . Firms use the application of elasticity to determine the substitution of inputs if one of the inputs price goes up. Policy makers use the application of elasticity to determine which factors contribute most to the growth of the Gross Domestic Product (GDP).Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 4– 6
7. 7. TYPES OF ELASTICITY • Price elasticity of demand • Price elasticity of supply • Cross price elasticity • Income elasticityMicroeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 4– 7
8. 8. PRICE ELASTICITY OF DEMAND • Measures how much the quantity demanded of a good responds to a change in the price of that good. • It is computed as a percentage change in quantity demanded divided by a percentage change in price.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 4– 8
9. 9. FORMULA FOR PRICE ELASTICITY OF DEMAND USING THE POINT FORMULA • The point formula is used to calculate the price elasticity of demand between two points on a demand curve. • The formula is shown below: Price elasticity : Percentage Change in Quantity DemandedMicroeconomics Percentage Change in Price Rights Reserved All© Oxford University Press Malaysia, 2008 4– 9
10. 10. FORMULA FOR PRICE, ELASTICITY OF DEMAND USING THE MIDPOINT FORMULA (CON’T)• Computes a percentage change by dividing the change by the midpoint (average) at the initial and endpoint.• The formula is shown below: Q1-Q0 [ (Q1-Q0)/2 ] ∆Q (P0 + P1)/2 = X P1-P0 ∆P (Q0 + Q1)/2 [ (P1-P0)/2 ]Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 4– 10
11. 11. TYPES OF PRICE ELASTICITY OF DEMAND • Elastic, E>1 • Inelastic, E < 1 • Unit Elastic, E = 1 • Perfectly Inelastic, E = 0 • Perfectly Elastic, E = αMicroeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 4– 11
12. 12. FACTORS AFFECTING ELASTICITY OF DEMAND Availability of close substitutes Necessities versus luxuries Market Time horizon Proportion of consumer’s expenditureMicroeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 4– 12
13. 13. PRICE ELASTICITY AND TOTAL REVENUE Inelastic: P ↑ Q ↓ TR ↓ P ↓ Q ↓TR ↓ Elastic : P ↑ Q ↑ TR ↓ P ↑ Q ↓ TR ↓Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 4– 13
14. 14. ELASTICITY OF A LINEAR DEMAND CURVE• At points with low price and high quantity, the demand curve is inelastic. Unitary elasticity is equal to 1• At points with high price and low quantity, the demand curve is elastic.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 4– 14
15. 15. INCOME ELASTICITY OF DEMAND • Measures how much the quantity demanded of a good responds to a change in consumers income. • It is computed as a percentage change in quantity demanded divided by a percentage change in income.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 4– 15
16. 16. FORMULA FOR INCOME ELASTICITY OF DEMAND The formula for income elasticity of demand is shown below: Percentage Change in Income Quantity Demanded elasticity of = demand Percentage Change in IncomeMicroeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 4– 16
17. 17. THE USES OF INCOME ELASTICITY Used to classify goods into luxury goods, normal goods, necessary goods or inferior goods. Used to predict market potential. If one good has a high value income elasticity, the producer can predict an increase and decrease in sales when the elasticity coefficient falls.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 4– 17
18. 18. DEGREES OF INCOME ELASTICITY• EY= 0, perfectly elastic necessary goods• EY >0, elastic, luxury goods• 0 < EY < 1, inelastic, normal goods• EY < 0, negative elastic, inferior goodsMicroeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 4– 18
19. 19. CROSS PRICE ELASTICITY OF DEMAND Measures how the quantity demanded of a good responds to a change in the price of another good. It is computed as a percentage change in quantity demanded of good 1 divided by the percentage change in the price of good 2.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 4– 19
20. 20. FORMULA FOR CROSS PRICE ELASTICITY OF DEMAND The formula for cross price elasticity of demand is shown below: Cross price Percentage change in quantity elasticity of demanded of good 1 demand = Percentage change in price of good 2Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 4– 20