Elasticity revision

1. Elasticity

2. Elasticity
• 4 basic types used:
• Price elasticity of demand
• Price elasticity of supply
• Income elasticity of demand
• Cross elasticity of demand

3. Elasticity
Defining Elasticity
elasticity measures the percentage change of one economic variable in response to a
percentage change in another.
Price elasticity of demand
The price elasticity of demand is the ratio of the percentage change in the quantity
demanded to the percentage change in the price as we move along the demand curve
• Price Elasticity of Demand
o The responsiveness of demand to changes in price
o Where % change in demand is greater than % change in price –
elastic
o Where % change in demand is less than % change in price - inelastic

5. .

7. • The price elasticity of demand for petrol is defined
as the percentage change in quantity demanded
divided by the percentage change in price. (Ignore
any minus signs).
• Calculate the price elasticity of demand
• In this example, the price elasticity of petrol is 2.5%
/ 15% = 0.167.
• Goods with price elasticities less than 1.0 are
inelastic

8. Government
• Governments like to tax goods with inelastic demand curves. The diagram illustrates
the effect of a 10 cents per litre tax; a shift of the Supply Curve from S to S1.
• Petrol station owners will notice a small fall in sales; but the effect on their profits is
small.
• Governments do not like to be accused of driving small business out of business!
• Other goods with high levels of taxation include alcohol and cigarettes: both very
inelastic. Explain impact…
• will generate increased tax revenue
• tax can be used for health
• has larger impact on lower wage earners to buy goods

9. 9
• When total revenue moves
in the opposite direction to
the price change, demand is
elastic.
• Example:
Price TR
Price TR
Total Revenue Method

10. 10
• At $1 consumers demand 100 units and the revenue equals
$100.
• At 99c consumers demand 105 units and revenue equals
$103.95.
• By price, Revenue . Demand is therefore elastic.
Total Revenue Method

11. Total Revenue Method
Price
Quantity Demanded (000s)
D
The importance of elasticity
is the information it
provides on the effect on
total revenue of changes in
price.
$5
100
Total revenue is price x
quantity sold. In this
example, TR = $5 x 100,000
= $500,000.
This value is represented by
the grey shaded rectangle.
Total Revenue

12. Elasticity
Price
Quantity Demanded (000s)
D
If the firm decides to
decrease price to (say) $3,
the degree of price
elasticity of the demand
curve would determine the
extent of the increase in
demand and the change
therefore in total revenue.
$5
100
$3
140
Total Revenue

13. inelasticity
Price ($)
Quantity Demanded
10
D
5
5
6
% Δ Price = -50%
% Δ Quantity Demanded = +20%
Ped = -0.4 (Inelastic)
Total Revenue would fall
Producer decides to lower price to attract sales
Not a good move!

14. Elasticity
Price ($)
Quantity Demanded
D
10
5 20
Producer decides to reduce price to increase sales
7
% Δ in Price = - 30%
% Δ in Demand = + 300%
Ped = - 10 (Elastic)
Total Revenue rises
Good Move!

15. Elasticity
• If demand is price elastic:
• Increasing price would reduce
TR (%Δ Qd > % Δ P)
• Reducing price would increase
TR
(%Δ Qd > % Δ P)
• If demand is price inelastic:
• Increasing price would increase
TR
(%Δ Qd < % Δ P)
• Reducing price would reduce TR
(%Δ Qd < % Δ P)

16. Factors affecting Elasticity of Demand
• Time period – the longer the time under consideration the more elastic a good is
likely to be.
• Short run demand relatively inelastic no time to adjust, long run demand
relatively elastic E.g. installing LPG in car, trading car in on a hybrid
• Number and closeness of substitutes – the greater the number of substitutes the
more elastic. Brands of petrol
• Price elasticity of a brand is greater than the price elasticity of a good

17. Factors affecting Elasticity of Demand
• The proportion of income taken up by the product – the smaller the
proportion the more inelastic
• Expensive goods are likely to be relatively price elastic Why?
• Because they take up a larger proportion of income
• Luxury or Necessity – necessity goods such as food & drugs will be
price inelastic
• Luxury items will be price elastic

18. Elasticity
• Income Elasticity of Demand:
• The responsiveness of demand to changes in incomes
• Normal Good – demand rises as income rises and vice versa
• Inferior Good – demand falls as income rises and vice versa

19. Elasticity
• Income Elasticity of Demand:
• A positive sign denotes a normal good
• A negative sign denotes an inferior good

20. Elasticity
• For example:
• Yed = - 0.6: Good is an inferior good but inelastic – a rise in income of 3% would lead to demand
falling by 1.8%
• Yed = + 0.4: Good is a normal good but inelastic – a rise in incomes of 3% would lead to demand
rising by 1.2%
• Yed = + 1.6: Good is a normal good and elastic – a rise in incomes of 3% would lead to demand
rising by 4.8%
• Yed = - 2.1: Good is an inferior good and elastic – a rise in incomes of 3% would lead to a fall in
demand of 6.3%

21. • An income reduction of 15% causes Geoff to increase his purchases of
minced beef by 10%.
• Which of the following statements is most likely to be correct?
A. The income elasticity of demand for minced beef is -2/3 and ground beef
is a superior good
B. The price elasticity of demand for ground beef is -1.5 and ground beef is
a normal good
C. The income elasticity of demand for minced beef is -2/3 and ground beef
is an inferior good
D. The price elasticity of demand for ground beef is -2/3 and minced beef is
a normal good

22. Elasticity
• Cross Elasticity:
• The responsiveness of demand of one good to
changes in the price of a related good – either a
substitute or a complement
Xed =
% Δ Qd of good t
__________________
% Δ Price of good y

23. Elasticity
• Goods which are complements:
• Cross Elasticity will have negative sign (inverse relationship between the two)
• CPeD ≤ 0 two goods are Comp
• Goods which are substitutes:
• Cross Elasticity will have a positive sign (positive relationship between the
two)
• CPeD ≥ 0 two goods are subs

24. • An increase in the price of hot dogs from $1.50 to $2.10 per kilo
increased the average number of beef burgers demanded per week
from 300 to 360.
• the cross-price elasticity of demand between hot dogs and beef
burgers is ______? which indicates that the two goods are _________
• [A]+0.5 or 1/2 [B]substitutes

25. • The price of good X falls by 15 %. As a result, the demand for a
substitute good Y rises by 30 %.
• What is the cross-elasticity of demand for good Y with respect to
good X?
• -2 (i.e. the two goods are close complements)

26. Elasticity
• Price Elasticity of Supply:
• The responsiveness of supply to changes in price
• If Pes is inelastic - it will be difficult for suppliers to
react swiftly to changes in price
• If Pes is elastic – supply can react quickly to changes in
price
Pes =
% Δ Quantity Supplied
____________________
% Δ Price

27. Factors affecting Elasticity of Supply
• Time period – if a producer can respond quickly to a price change then supply
will be price elastic
• Short run difficult for a producer to increase output – price inelastic
• Nature of industry– supply of agriculture products tends to be relatively price
inelastic
• Supply of manufactured goods is more price elastic
• Wheat, wool and meat require reasonable amount of time

28. Importance of Elasticity
• Relationship between changes in price and total revenue
• Importance in determining what goods to tax (tax revenue)
• Importance in analysing time lags in production
• Influences the behaviour of a firm