2. The Concept of Elasticity
Elasticity is a measure of the
responsiveness of one variable to another.
The greater the elasticity, the greater the
responsiveness.
3. LAW OF DEMAND
Law of demand states that if price of commodity
increases quantity demanded will falls and vice
versa.
Law of demand indicates only direction of
change in quantity demanded in response to
change in price but ELASTICITY OF DEMAND
states with how much or to what extent the
quantity demanded will change in response to
change in price
4. ELASTICITY OF DEMAND:
MEANING
- Percentage change in quantity demanded
divided by percentage change in price.
-BY MARSHALL
-Measures the responsiveness of quantity
demanded of a good to the change in its
price.
–BY BOULDING
Ed = % change in quantity demanded divided
by %change in price
5. Price Elasticity of Demand
A measure of how much the quantity demanded
of good responds to a change in the price of that
good
Computed as the percentage change in quantity
demanded divided by the percentage change in
price.
We know if we raise a price, the Qd will decline,
but we don’t know how much.
Elasticity answers the “how much” question.
In Business, we want to know the relationship
between Qd and Price
Ep = % Change in Quantity Demanded
% Change in Price
6. Calculating Percentage Change
Percentage Change measures how much a
value has changed from one time period to
another
There are two methods of calculating the
percentage change
• Simple Method
• Midpoint Method
7. Calculating Percentage Change
For Example, if a firm’s sales for the current month
amounted to $100 million and the previous month,
the same firm’s sales were $90 million. What was
the percentage change?
Simple Method
Percentage Change = Current Value-Previous Value
Previous Value
or, = $100m - $90 m = $10m = 11.1%
$90m $90m
Very Common Usage, especially in the business
world
8. Calculating Percentage Change
Midpoint Method
Percentage Change = Current Value – Previous Value
(Current Value + Previous Value)/ 2
Or, = $100m -$90m = $10m = 10.5%
($100m + $90m)/2 $95m
The midpoint method is the better method
because it gives similar results whether we are
measuring forward or backward
9. Determinants Of Elasticity of
Demand
From Formula Ep = % Change in Qd
% Change in Price
If Price Elasticity of Demand > 1, demand is
elastic
If Price Elasticity of Demand = 1, demand is unit
elastic
If Price Elasticity of Demand < 1, demand is
inelastic
10. Demand Elasticity
Elastic Demand – When % Change in Quantity
Demanded > % Change in Price
Unit Elastic Demand – When % Change in
Quantity Demanded = % Change in Price
Inelastic Demand – When % Change in Quantity
Demanded < % Change in Price
Perfectly Elastic Demand – When Quantity
Demanded Changes by a very large percentage
in response to an almost zero Change in Price
Perfectly Inelastic Demand – When the Quantity
Demanded remains constant as Price changes
11. Perfectly Elastic Demand Curve
14
12
10
8 D
6
4
2
5 10 15 20 25 30
Quantity
The elasticity of a perfectly elastic demand curve is infinity
12. Perfectly Inelastic Demand Curve
D
30
25
20
15
10
5
5 10 15 20 25
Quantity
The elasticity of a perfectly inelastic demand curve is 0
14. Elasticity of Straight Line Demand Curve
11
Very elastic
10
e = 6.33
9
8
Slightly elastic
7
Unit elastic
6 e = 1.0
Slightly inelastic
5
4
3 e = .29
Very
inelastic
2
1
D
0
0 1 2 3 4 5 6 7 8 9 10 11
Quantity
15. Significance of Price Elasticity of
Demand
Profit maximization requires that business set a
price that will maximize the firm’s profit
Elasticity tells the firm how much control it has
over using price to raise profit
If Ep > 1, then the % Change in Qd > %
Change is Price and demand is said to be elastic
• An increase in price will reduce total revenue
• A decrease in price will increase total revenue
16. Significance of Price Elasticity of
Demand
If Ep < 1, then the % change in Qd < % change
in price, and demand is said to be inelastic
• An increase in price will increase total revenue
• A decrease in price will decrease total revenue
If Ep = 1, then the % change in Qd = % change
in Price, and demand is said to be unit elastic
• An increase in price will have no impact on
total revenue
• A decrease in price will have no impact on
total revenue
17. Price Elasticity of Demand Influences
Substitute Product Availability (key determinant)
-- Luxury or Necessity (Ep for luxury items is >)
-- How narrowly it is defined (coffee is inelastic
but tea may have more substitutes and therefore
is more elastic)
-- Time elapsed since price change (>time,
>elasticity; more time to find substitutes or
manage consumption)
Income Effects
-- The greater the proportion of income spent
on the good, greater a price change impacts
Quantity Demanded
18. Advertising
Purpose – Product Differentiation (Branding)
To make the demand for a product greater
To make the demand for a product more
inelastic
D D
19. Elasticity Thoughts
Demand Curve Slope and Elasticity (Steeper the slope,
lower the elasticity)
A Units-Free Measure (% Change – Absolute Value)
Elasticity Along a Linear Demand Curve
-- Slope is constant but elasticity varies
Elasticity and Total Revenue
-- Price and Total Revenue change in opposite
directions, demand is elastic
-- Price Change leaves Total Revenue unchanged,
demand is unit elastic
-- Price and Total Revenue change in same direction,
demand is inelastic
20. Price Elasticity of Supply
A measure of the extent to which the
quantity supplied of a good changes when
the price of the good changes, and all
other influences on seller’s plans remain
the same (cateris paribus)
21. Price Elasticity of Supply
Perfectly Elastic Supply – When the quantity supplied
changes by a very large percentage in response to an
almost zero increase in price
Elastic Supply – When the % change in the quantity
supplied > the % change in the price
Unit Elastic Supply – When the % change in the quantity
supplied = the % change in price
Inelastic Supply – When the % change in the quantity
demanded is < the % change in price
Perfectly Inelastic Supply – When the quantity supplied
remains the same as the price changes
22. Influences on Price Elasticity of Supply
Production Possibilities
-- Opportunity Costs
constant or gently rising opportunity costs
= elastic price elasticity
-- Fixed Production = inelastic price elasticity
-- Time Elapse – longer time, > price elasticity
23. Influences of Price Elasticity of Supply
Storage Possibilities
The better the storability, the more elastic is the
price elasticity of supply
24. Computing Price Elasticity of Supply
Percentage change in quantity supplied
Percentage change in price
• If Price Elasticity of Supply > 1, Supply is elastic
• If Price Elasticity of Supply = 1, Supply is unit elastic
• If price elasticity of supply< 1, Supply is inelastic
25. Cross Elasticity of Demand
A measure of the extent to which the demand
for a good changes when the price of a
substitute or complement changes, ceteris
paribus
% Change in Quantity Demanded
% Change in Price of one of its Substitutes or complements
26. Income Elasticity of Demand
A measure of the extent to which the
demand for a good changes when income
changes, ceteris paribus
% Change in Quantity Demanded
% Change in Income
27. Income Elasticity of Demand
If income elasticity of demand > 1 the demand
for the good is income elastic
If income elasticity of demand is between
0 and 1, the demand is income inelastic
* If income elasticity of demand < 0 the
demand is negative income elastic