Economics Presentation.


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Economics Presentation.

  1. 1. Chapter 4 Price and income elasticity $ Price <ul><li>Quantity </li></ul><ul><li>demanded </li></ul><ul><li>supplied </li></ul>$ Income
  2. 2. Lecture Plan <ul><li>Price elasticity of demand </li></ul><ul><li>Measuring price elasticity of demand </li></ul><ul><li>Income elasticity of demand </li></ul><ul><li>Price elasticity of supply </li></ul><ul><li>Measuring price elasticity of supply </li></ul><ul><li>Factors affecting elasticity of demand </li></ul><ul><li>Factors affecting elasticity of supply </li></ul>
  3. 3. Price Elasticity of Demand <ul><li>How responsive consumers are to a change in the price of a product </li></ul><ul><li>Types: </li></ul><ul><ul><li>Elastic demand </li></ul></ul><ul><ul><li>Inelastic demand </li></ul></ul><ul><ul><li>Unit elasticity </li></ul></ul><ul><ul><li>Perfectly elastic demand </li></ul></ul><ul><ul><li>Perfectly inelastic demand </li></ul></ul>
  4. 4. 1. Elastic Demand <ul><li>Small price changes lead to large changes in the quantity demanded </li></ul><ul><li>E.g. a product with many substitutes </li></ul><ul><li>Consumer demand is relatively responsive to price changes </li></ul>
  5. 5. 2. Inelastic Demand <ul><li>Consumers’ demand is relatively unresponsive to price changes (i.e. a large price change causes only a small change in quantity demanded) </li></ul><ul><ul><li>E.g. cigarettes, essentials </li></ul></ul>
  6. 6. 3. Unit Elasticity ( E d = 1) <ul><li>A change in price causes an equal change in Q d </li></ul><ul><li>e.g. a 10% increase in P causes a 10% decrease in Q d </li></ul>
  7. 7. 4. Perfectly Elastic Demand ( E d =  <ul><li>A change in price causes quantity demanded to be non-existent </li></ul><ul><li>This is one theoretical extreme </li></ul>
  8. 8. 5. Perfectly Inelastic Demand ( E d = 0) <ul><li>A change in price causes no change in the quantity demanded </li></ul><ul><li>E.g. drugs of addiction, essential medicines </li></ul><ul><li>This is the other theoretical extreme </li></ul>
  9. 9. Measuring Elasticity of Demand <ul><li>Two methods: </li></ul><ul><li>Total revenue method </li></ul><ul><li>Point method </li></ul>
  10. 10. <ul><li>Total revenue = the amount received by firms from </li></ul><ul><li>consumers buying goods/services </li></ul><ul><li> = Price × Quantity </li></ul><ul><li> TR = P × Q </li></ul>1. Total revenue method
  11. 11. Example A <ul><li>A firm decides to reduce the price of its product from $10 to $8. Quantity demanded will increase from 30 to 40 units sold </li></ul><ul><li>At P = $10, TR = 10 x 30 = $300 </li></ul><ul><li>At P = $8, TR = 8 x 40 = $320 </li></ul><ul><li>Due to the price decrease, TR has risen </li></ul><ul><li>DEMAND IS ELASTIC </li></ul>
  12. 12. Example B <ul><li>The firm decides to reduce price further from $8 to $6 ( Q d at $6 is 50 units) </li></ul><ul><li>At P = $8, TR = $320 </li></ul><ul><li>At P = $6, TR = 6 x 50 = $300 </li></ul><ul><li>TR has fallen, DEMAND IS INELASTIC </li></ul>P Q D 10 8 6 30 40 50 A B C
  13. 13. Summary of Total Revenue Method <ul><li>When TR moves in the opposite direction to a price change, demand is ELASTIC </li></ul><ul><li>If TR remains the same when price changes then demand has UNITARY ELASTICITY </li></ul><ul><li>When TR moves in the same direction as the price change then demand is INELASTIC </li></ul>
  14. 14. 2. The Point Method <ul><li>The degree of elasticity can be measured by the elasticity coefficient , or E d in this formula: </li></ul><ul><li> E d = percentage change in Q d percentage change in price </li></ul><ul><li>Note: </li></ul><ul><li>% change in Q d = change in Q d × 100 original Q d 1 </li></ul><ul><li>% change in price = change in price × 100 original price 1 </li></ul>
  15. 15. Interpretations <ul><li>Elastic demand : a given % change in price results in a larger % change in Q d </li></ul><ul><li>E.g. 2% decline in price results in a 4% increase in Q d </li></ul><ul><li>E d = 4/2 = 2 </li></ul><ul><li>Where demand is elastic, E d > 1 </li></ul><ul><li>Note: it is conventional to ignore the minus sign </li></ul>(cont.)
  16. 16. Interpretations (cont.) <ul><li>Inelastic demand : a % change in price is accompanied by a relatively smaller change in Q d </li></ul><ul><li>E.g. 3% decline in price leads to a 1% increase in Q d </li></ul><ul><li>E d = 1/3 </li></ul><ul><li>Where demand is inelastic, E d < 1 </li></ul><ul><li>Unitary elasticity E d = 1 </li></ul>
  17. 17. Income Elasticity of Demand <ul><li>Measures responsiveness of the demand for a product due to changes in income </li></ul><ul><li>Cross elasticity of demand: measures how the Q d of one good responds to changes in the price of another good </li></ul>
  18. 18. Price Elasticity of Supply <ul><li>The responsiveness of producers to changes in the price of a product i.e. ‘how much more’ will be supplied in response to a price rise? </li></ul><ul><li>Measuring elasticity of supply </li></ul><ul><li>E s = % change in Q s </li></ul><ul><li> % change in price </li></ul>
  19. 19. Factors affecting elasticity of demand <ul><li>Availability of substitutes </li></ul><ul><li>Necessity </li></ul><ul><li>Habit and desirability </li></ul><ul><li>Proportion of income </li></ul><ul><li>Complementary products </li></ul><ul><li>Time </li></ul>
  20. 20. Factors affecting elasticity of supply <ul><li>Time </li></ul><ul><li>Ability to hold stocks </li></ul><ul><li>Excess capacity </li></ul><ul><li>Business expectations </li></ul>