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# Elasticity2

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### Elasticity2

1. 1. ELASTICITY cont’d.
2. 2. Total expenditure and Price Elasticity of Demand There is an important relationship between Price Elasticity of Demand and Total Expenditure (Revenue). def: Total expenditure (TR) = Price X Quantity
3. 3. Total expenditure and Price Elasticity of Demand • if demand is elastic, expenditure increases as price falls , • if demand is inelastic, expenditure increases as price rises .
4. 4. Table #1 Sample Demand Schedule pt. QD TR A 6 1 \$6 B 5 2 \$10 C 4 3 \$12 D 3 4 \$12 E 2 5 \$10 F   P 6 1 \$6
5. 5. A-B = -11/3 B-C = -9/5 C-D = -1 D-E = -5/9 E-F = -3/11
6. 6. Notice the relationship between price elasticity of demand and total expenditure: • From B-C, the price elasticity of demand was -9/5 (therefore, demand is elastic since the absolute value of -9/5 is greater than 1). Also, from B-C, total expenditure increased as price fell.
7. 7. • Now refer back to the table above and see the following relationships: • When demand is elastic, total expenditure rises as price falls (see A-B or B-C) • When demand is unit elastic, total expenditure is at its maximum, and does not change when price changes (see C-D) • When demand is inelastic, total expenditure rises as price rises (see E-D or F-E)
8. 8. Price (dollars per TV) Demand and Total Expenditure Expenditure loss 400 elasticity = 0.6 300 200 Expenditure gain 100 Db 40 60 80 120 Quantity (millions of TVs per year)
9. 9. Elasticity and Expenditure • Elastic demand — 1 % price decrease results in more than a 1 % increase in quantity. • Total expenditure will increase
10. 10. Elasticity and Expenditure • Inelastic demand — 1 % price decrease results in less than a 1 % increase in quantity. • Total expenditure will decrease
11. 11. Elasticity and Expenditure • Unit elastic demand — 1 % price decrease results in a 1 % increase in quantity. • Total expenditure does not change
12. 12. Income Elasticity of Demand
13. 13. Income Elasticity of Demand • Normal Goods - A good is a normal good if its income elasticity is positive. This means that when income rises, quantity demanded rises - most goods are normal goods. Also, as shown below, there are different types of normal goods:
14. 14. Income Elasticity of Demand • Necessity Goods - A good is a necessity if its income elasticity is positive, but less than 1. This means that if income rises by 10%, quantity demanded rises by less than 10% therefore, as people's income rises, they spend a smaller percentage of their income on necessities. • Luxury Goods - A good is a luxury good if its income elasticity is positive, and greater than 1. This means that if income rises by 10%, quantity demanded rises by more than 10% - therefore, people spend more of their income on luxuries when they have larger incomes
15. 15. Income Elasticity of Demand • Inferior Goods - A good is an inferior good if its income elasticity is negative. This means that when income rises, quantity demanded falls.
16. 16. Cross Elasticity of Demand Cross elasticity of demand= Percentage change in quantity demanded of good X Percentage change in price of good Y Complements have negative cross elasticities. Suplements have positive cross elasticities .
17. 17. Price Elasticity of Supply
18. 18. Determinants of Price Elasticity of Supply • The ability of producers to change output - the easier it is for producers to alter their output, the more elastic will be the supply of a product. • Time Horizon - The price elasticity of supply for most products is more elastic in the longrun than in the short-run. This is because a longer time horizon gives producers more opportunity to alter their output of a good.