2. Elasticity – the concept
The responsiveness of one variable to changes in
another
When price rises, what happens
to demand?
Demand falls
BUT!
How much does demand fall?
3. Elasticity – the concept
If price rises by 10% - what happens to demand?
We know demand will fall
By more than 10%?
By less than 10%?
Elasticity measures the extent to which
demand will change
4. Elasticity
4 basic types used:
Price elasticity of demand
Price elasticity of supply
Income elasticity of demand
Cross elasticity
5. Elasticity
Price Elasticity of Demand
The responsiveness of demand
to changes in price
Where % change in demand
is greater than % change in price – elastic
Where % change in demand is less than % change
in price - inelastic
6. Elasticity
Price ($)
Quantity Demanded
The demand curve can be a
range of shapes each of which
is associated with a different
relationship between price and
the quantity demanded.
7. Elasticity
The Formula:
Ped =
% Change in Quantity Demanded
___________________________
% Change in Price
If answer is between 0 and -1: the relationship is inelastic
If the answer is between -1 and infinity: the relationship is elastic
Note: PED has – sign in front of it; because as price rises
demand falls and vice-versa (inverse relationship between
price and demand)
8. Elasticity
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
9. 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
$3
140
Total Revenue
10. Elasticity
Price ($)
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!
11. 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!
12. The Meaning of Price Elasticity of
demand
Elastic Demand: A strong response to a change in pric
Unit Elastic demand: A proportional response to a pri
change (total amount spent by consumers remains
unchanged)
Inelastic demand : A weak response to a price change
13. 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)
14. Total Outlay Method
Total Outlay is a way
to calculate the price
elasticity of demand
method by looking at
the effect of changes
in price on the
revenue earned by
the producer.
If price and revenue
move in the same
direction, demand is
inelastic.
If price and revenue
move in the opposite
direction, demand is
elastic
If revenue remains
unchanged in
response to a price
change, demand is
unit elastic
16. Total Outlay Method and slope of a
demand curve
Look at Pg 85
Perfectly elastic Demand is where consumers are
willing to pay any price in order to obtain a given
quantity of a good or service. The situation can be
represented by a horizontal demand curve.
An apple grower sells apples, along with many
other apple growers , at a fruit and vegetable
market. The grower can sell the entire load at the
going market price. If the grower tries to sell the
apples at a price above the going rate he will sell
none.
17. Perfectly Inelastic demand is where consumers
are willing to pay any price in order to obtain a
give quantity of a good or service. This situation
can be represented by a vertical demand curve.
Example a person with a life threatening illness
would be willing to pay almost anything.
20. Factors affecting elasticity of demand
Whether the good is a luxury or a necessity.
-necessities have relative inelastic demand-even if
there is an increase in price, the quantity
demanded will not fall to a great extent
-price elasticity of demand is higher for products
that are regarded as luxuries
21. Factors affecting elasticity of demand
Whether the good has any close substitutes.
Goods with close substitutes tend to have highly
elastic demand.
If the price increases the demand is is likely to
contract more then proportionately.
Goods and Services with few or no close
substitutes , such as water supply, would have
inelastic demand- even if price increase, people
cannot switch to another product
22. Factors affecting elasticity of demand
The expenditure on the product as a proportion of
income
Items which take up a very small proportion of a
person’s income would have a lower price
elasticity of demand, whereas the demand for
more expensive items would tend to be more
elastic.
23. Factors affecting elasticity of demand
The length of time subsequent to a price change
If the price falls may take time to become aware
and adjust to the price change
If it increases, consumers may take time to seek
out alternatives and substitute products
24. Factors affecting elasticity of demand
Whether a good is habit forming (addictive) or not
Relative inelastic demand.
E.G Price rise in Alcho-pops and cigarettes did not
lead to a large decrease in demand.
REVIEW QUESTION 1-3 pg 87
Chapter Review pg 89
