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- 1. Topics Measurement Kinds Type Importance
- 2. 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. 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. A. Absolute elasticity Qd = a – b P B. Current elasticity E = △Q/P△
- 5. Elastic E >1Inelastic E<1Unit Elastic E=1
- 6. 4 basic types used: Price elasticity of demand Price elasticity of supply Income elasticity of demand Cross elasticity
- 7. 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
- 8. The Formula: % Change in Quantity Demanded ___________________________ Ped = % Change in Price If answer is between 0 and -1: the relationship is inelasticIf the answer is between -1 and infinity: the relationship is elasticNote: PED has – sign in front of it; because as price risesdemand falls and vice-versa (inverse relationship betweenprice and demand)
- 9. Price (£) The demand curve can be a range of shapes each of which is associated with a different relationship between price and the quantity demanded. Quantity Demanded
- 10. Price Total revenue is price x The importance of elasticity quantity sold. In this is the information it example,on the£5 x 100,000 provides TR = effect on = £500,000. of changes in total revenue price. This value is represented by the grey shaded rectangle. £5 Total Revenue D 100 Quantity Demanded (000s)
- 11. ElasticityPrice 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 £5 revenue. £3 Total Revenue D 100 140 Quantity Demanded (000s)
- 12. Price (£) Producer decides to lower price to attract sales 10 % Δ Price = -50% % Δ Quantity Demanded = +20% Ped = -0.4 (Inelastic) 5 Total Revenue would fall Not a good move! D 5 6 Quantity Demanded
- 13. Price (£) Producer decides to reduce price to increase sales % Δ in Price = - 30% % Δ in Demand = + 300% Ped = - 10 (Elastic) Total Revenue rises 10 Good Move! 7 D 5 Quantity Demanded 20
- 14. If demand is price If demand is price elastic: inelastic: Increasing price Increasing price would reduce TR (%Δ would increase TR Qd > % Δ P) (%Δ Qd < % Δ P) Reducing price would Reducing price would increase TR reduce TR (%Δ Qd < (%Δ Qd > % Δ P) % Δ P)
- 15. 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
- 16. Income Elasticity of Demand: A positive sign denotes a normal good A negative sign denotes an inferior good
- 17. 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%
- 18. Cross Elasticity: The responsiveness of demand of one good to changes in the price of a related good – either a substitute or a complement % Δ Qd of good t __________________ Xed = % Δ Price of good y
- 19. Goods which are complements: Cross Elasticity will have negative sign (inverse relationship between the two) Goods which are substitutes: Cross Elasticity will have a positive sign (positive relationship between the two)
- 20. 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 % Δ Quantity Supplied Pes = ____________________ % Δ Price
- 21. Time period – the longer the time under consideration the more elastic a good is likely to be Number and closeness of substitutes – the greater the number of substitutes, the more elastic The proportion of income taken up by the product – the smaller the proportion the more inelastic Luxury or Necessity - for example, addictive drugs
- 22. 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

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