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# 12776668 elasticity

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### 12776668 elasticity

1. 1. Price Elasticity of Demand and Supply Tutor2u Economics March 2001 Price Elasticity of Demand and Supply
2. 2. Definition of Price Elasticity Price elasticity (Ped) measures responsiveness of demand to change in price of good itself Ped = % change in Qdx / % change in Px When price falls we expect to see an expansion of demand When price rises we expect to see a contraction of demand Therefore an inverse relationship between price and demand (negative value for Ped) Price Elasticity of Demand and Supply
3. 3. Price elasticity of demand % change in quantity demanded Ped = % change in price Ped > 1 elastic demand Ped = 1 unit-elastic demand Ped < 1 inelastic demand Price Elasticity of Demand and Supply
4. 4. Straight-line demand curve Price ED > 1 El ast i c ED = 1 Unit elastic In ela ED < 1 st i c 0 Quantity demanded Price Elasticity of Demand and Supply
5. 5. Extreme values for elasticity Price D Price D Insulin Perfectly inelastic demand Perfectly elastic demand ED = 0 ED = o o Price Elasticity of Demand and Supply
6. 6. Range and Meaning of PedType Value of ε MeaningPerfectly 0 No change in quantity whenInelastic price changesInelastic <1 Quantity changes by less than priceUnit Elasticity 1 Quantity & price change by same %Elastic >1 Quantity changes by more than pricePerfectly ∞ Demand only exists at oneElastic price Price Elasticity of Demand and Supply
7. 7. Factors that determine Ped The closer the substitutes for a good, the more elastic is demand The more substitutes for a good, the more elastic is demand The lower the cost of substitution the more elastic is demand The higher the proportion of income spent on a good, the more elastic is demand The greater the time elapsed since a price change, the more elastic is demand Necessities have an inelastic demand. Luxuries have more elastic demand. Habit forming goods tend to have an inelastic demand Price Elasticity of Demand and Supply
8. 8. Elastic or inelastic demand? Gateway cuts the price of their desktop PCs by 10% A fall in the price of Euro-star tickets An increase in the price of the Financial Times A taxi home from a night-club on a Friday night A rise in average car insurance premiums A two week foreign holiday for a student to Greece Motorway petrol prices rise by 5% after the budget Vodafone cuts their mobile phone charges Price Elasticity of Demand and Supply
9. 9. Time Frame and Elasticity Longer time frame => more elastic demand Two World oil price shocks of the 1970s  Response to higher oil prices was modest in the immediate period after price increases,  As time passed, people found ways to consume less petroleum and other oil products better mileage from their cars higher spending on insulation in homes car pooling for commuters  Car manufacturers invested enormous sums in more fuel efficient vehicles Price Elasticity of Demand and Supply
10. 10. Using price elasticity of demand How much tax revenue will higher “sin taxes” on cigarettes and alcohol provide? Why do airlines often give discounts for advance bookings? What happens to our demand for foreign holidays when the exchange rate appreciates? Why do hotels lower rates at weekends? Will a business always pass on higher costs to consumers? Will the introduction of road tolls cut road congestion? Price Elasticity of Demand and Supply
11. 11. Elasticity and total revenue Price A 0 What happens to total revenue as 8 price falls? B £30 6 C £40 4 D £30 2 E 0 0 5 10 15 20 Quantity demanded Price Elasticity of Demand and Supply
12. 12. Price Elasticity of Supply Elasticity of supply - responsiveness of the quantity supplied of a good to a change in its price Elasticity of supply (Pes) is the  % change in quantity supplied divided by the % change in price  Normally as price rises - so does supply Price Elasticity of Demand and Supply
13. 13. Price elasticity of supply % change in quantity supplied ES = % change in price ES > 1 price-elastic supply ES = 1 unit-elastic supply ES < 1 price-inelastic supply Price Elasticity of Demand and Supply
14. 14. What Determines Supply Elasticity? Factor substitution possibilities  Can labour/capital be switched easily  When substitution is possible, supply is elastic Spare production capacity available Stocks (inventories) available to meet changes in demand Time frame for the supply to the market  Momentary period (fixed supply)  Short run (inelastic supply)  Long run (elastic supply) Price Elasticity of Demand and Supply
15. 15. Applying concept of Pes Seats in a football stadium  Short run capacity is fixed  Long run – expansion of stadium capacity Supply of seat-belts when the government made them compulsory  Substitutability of factors of production? An increase in demand for fresh salmon  Time lags in the production process World supply of oil following a large rise in world demand  Amount of spare capacity of major oil producers  Can stocks be put onto the market to meet the rise in demand? Price Elasticity of Demand and Supply
16. 16. Elasticity of Supply and Time Frame Momentary Supply Price Short Run Supply Long Run Supply Quantity supplied per time period Price Elasticity of Demand and Supply
17. 17. Short Run Elasticity of Supply Short Run Supply Price of kitchens D2 D1 Quantity supplied per time period Price Elasticity of Demand and Supply
18. 18. Long-run elasticity of supply Short Run Supply Price of kitchens Long Run Supply D3 D2 D1 Quantity supplied per time period Price Elasticity of Demand and Supply
19. 19. Extreme values for Pes ES = 0 Price ES = 1 Unit elastic Perfectly elastic ES = o o Perfectly inelastic Quantity supplied Price Elasticity of Demand and Supply