Elasticity

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An introduction to the concept and uses of elasticity, for Basic Microeconomics students, especially for USLS CO2D class, 1st semester 2013-14

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Elasticity

  1. 1. SpecialTopic in Basic Microeconomics Jean Lee C. Patindol
  2. 2.  Elasticity is a general concept that can be used to quantify the response in one variable when another variable changes. e l a s t i c i t y o f A w i t h r e s p e c t t o B A B = % % ∆ ∆ Jean Lee C. Patindol
  3. 3.  a measure of the responsiveness of quantity to the percentage changes in what affects it % c h a n g e i n q u a n t i t y d e m a n d e d x 1 0 0 %2 = −Q Q Q 1 1 % c h a n g e i n p r i c e x 1 0 0 %2 = −P P P 1 1 Jean Lee C. Patindol
  4. 4.  A more accurate way of computing elasticity than percentage changes is the midpoint formula: % % ( ) / ( ) / ∆ ∆ Q P Q Q Q Q P P P P d = − + − + 2 1 1 2 2 1 1 2 2 1 0 0 % 2 x x 1 0 0 % % % ( ) / ( ) / . . ∆ ∆ Q P d = − + − + = = − 1 0 5 5 1 0 2 1 0 0 % 2 3 3 2 2 5 7 5 1 6 7 x x 1 0 0 % x 1 0 0 % - 1 2 .5 x 1 0 0 % = 6 6 .7 % - 4 0 .0 % Jean Lee C. Patindol
  5. 5.  Price Elasticity (of Demand) – the ratio between the percentage change in quantity demanded to a corresponding percentage change in price. e = % ∆ Q/ Q or [(Q2 – Q1)/ Q1 ] x 100 ________ ____________________ % ∆ P/ P [(P2 - P1) / P1 ] x 100 Jean Lee C. Patindol
  6. 6.  Unitary (= 1): a percentage change in price is equal to the same percentage change in quantity demanded. The total revenue obtained remains constant despite the price change.  Elastic (> 1): a change in price will result in a more than proportionate change in quantity demanded. Higher total revenues are obtained by lowering prices. This is usually true for non-necessary items.  Inelastic ( < 1): a change in price will result to a less than proportionate change in quantity demanded. Higher total revenues are obtained by increasing prices. This is usually true for basic products like staple food, medicine, and other necessary items. Jean Lee C. Patindol
  7. 7.  When demand does not respond at all to a change in price, demand is perfectly inelastic.  Demand is perfectly elastic when quantity demanded drops to zero at the slightest increase in price. Jean Lee C. Patindol
  8. 8. Here is how to interpret two different values of elasticity:  When ε = 0.2, a 10% increase in price leads to a 2% decrease in quantity demanded.  When ε = 2.0, a 10% increase in price leads to a 20% decrease in quantity demanded. Jean Lee C. Patindol
  9. 9. Table 1. Demand Schedule for Rice Price (P) Quantity Demanded (Qd ) Total Revenue (P x Qd ) 50 8 P400 40 9 360 30 10 300 20 11 220 10 12 120 • What is the price elasticity of demand for rice if you decrease your price from P40 to P20? Should you go ahead with the price decrease? Jean Lee C. Patindol
  10. 10. e = % ∆ Q/ Q or [(Q2 – Q1 ) / Q1 ] x 100 _______ ________________________ % ∆ P/ P [(P2 - P1 ) / P1 ] x 100 = [(11- 9) / 9] x 100 ___________________ [ (20 – 40) / 40 ] x 100 = 22.22 / - 50 = - 0.44 Jean Lee C. Patindol
  11. 11.  At -0.44 elasticity (less than 1), this means that the price elasticity of demand for rice is inelastic.  Lowering the price from P40 to P20 results in only a 0.44% increase (thus, the negative sign, to show the inversely proportional relationship between P and Qd) in quantity demanded.  Also, the total revenue to be obtained is decreased from P360 to P220. Thus, it is not advisable to decrease the price. Jean Lee C. Patindol
  12. 12. Hypothetical Demand Elasticities for Four Products PRODUCT % CHANGE IN PRICE (%∆P) % CHANGE IN QUANTITY DEMANDED (%∆QD) ELASTICITY (%∆QD  %∆P) Insulin +10% 0% 0.0 Perfectly inelastic Basic telephone service +10% -1% -0.1 Inelastic Beef +10% -10% -1.0 Unitarily elastic Bananas +10% -30% -3.0 Elastic Jean Lee C. Patindol
  13. 13. When demand is inelastic, price and total revenues are directly related. Price increases generate higher revenues. When demand is elastic, price and total revenues are indirectly related. Price increases generate lower revenues. Type of demand Value of Ed Change in quantity versus change in price Effect of an increase in price on total revenue Effect of a decrease in price on total revenue Elastic Greater than 1.0 Larger percentage change in quantity Total revenue decreases Total revenue increases Inelastic Less than 1.0 Smaller percentage change in quantity Total revenue increases Total revenue decreases Unitary elastic Equal to 1.0 Same percentage change in quantity and price Total revenue does not change Total revenue does not change T R P Q= × Jean Lee C. Patindol
  14. 14. Table 1. Demand Schedule for Rice Price (P) Quantity Demanded (Qd ) Total Revenue (P x Qd ) 50 8 P400 40 9 360 30 10 300 20 11 220 10 12 120 •What is the price elasticity of demand for rice if you increase your price from P20 to P30? Should you go ahead with your price increase? Jean Lee C. Patindol
  15. 15. e = % ∆ Q/ Q or [(Q2 – Q1 ) / Q1 ] x 100 ________ ________________________ % ∆ P/ P [(P2 - P1 ) / P1 ] x 100 = [(10- 11) / 11] x 100 ____________________ [(30 – 20) / 20 ] x 100 = - 9.09 ______ 50 = -0.18 Jean Lee C. Patindol
  16. 16.  Availability of substitutes -- demand is more elastic when there are more substitutes for the product.  Importance of the item in the budget -- demand is more elastic when the item is a more significant portion of the consumer’s budget.  Time dimension -- demand becomes more elastic over time. Jean Lee C. Patindol
  17. 17. Jean Lee C. Patindol
  18. 18.  the ratio between the percentage change in quantity demanded to a corresponding percentage change in income. ey = % ∆ Q/ Q __________ % ∆ Y/ Y Jean Lee C. Patindol
  19. 19.  the ratio of the relationship between the percentage change in the quantity demanded for one product and the percentage change in price of its substitute product e = % ∆ Qx / Qx ____________ % ∆ Py/ Py Jean Lee C. Patindol
  20. 20.  the ratio between the percentage change in quantity supplied to a corresponding percentage change in price; tends to increase in the long-run than in the short-run because ability of Supply to shift resources to production e = % ∆ Qs / Qs __________ % ∆ P/ P Jean Lee C. Patindol
  21. 21. Table 2. Income and Price Elasticities of Demand of Southeast Asian Travellers to the Philippines Country of Origin Income Elasticity of Demand Price Elasticity of Demand Indonesia 1.20 -0.21 Malaysia 1.98 -0.37 Singapore 1.75 -0.44 Thailand 0.65 -0.25 •Describe the income elasticities of demand of each country. Which country’s people are the most likely to travel to the Philippines with increases in their income? The least likely? •Describe the price elasticities of demand for travel services of each country. Do these countries’ people consider traveling to the Philippines ncessary or not? Jean Lee C. Patindol
  22. 22. Table 3. Demand Schedule for Super Cologne, P = P70 Price (P) Quantity Demanded (Qd ) Total Revenue (P x Qd ) 70 3 60 6 50 9 40 12 30 15 •What is the price elasticity of demand for Super Cologne if you decrease your price from P60 to P40? Should you go ahead with your price decrease? • ANSWER WITH (5): elasticity coefficient; type of elasticity; interpretation in terms of 10% change in price; interpretation in terms of effect on TR; decision on price decrease or not Jean Lee C. Patindol

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