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# Elasticity 1

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• This slide has a ten second gap in between each example to allow the teacher to explain how the figures have been calculated. This gap can be increased or reduced as appropriate using the custom animation tool.
• This slide has a ten second gap in between each example to allow the teacher to explain how the figures have been calculated. This gap can be increased or reduced as appropriate using the custom animation tool.
• This slide has a ten second gap in between each example to allow the teacher to explain how the figures have been calculated. This gap can be increased or reduced as appropriate using the custom animation tool.
• This slide also has an automatic response with ten second gaps in between each point. At this stage we have tried to keep things as simple as possible but to introduce issues that will be dealt with later in the course.
• ### Elasticity 1

1. 1. Price Elasticity of Demand
2. 2. Which of the products below would be affected a lot by a change in price and which ones would be impacted a little? heart transplant Snickers candy bar tomatoes salt Cars (short run) gasoline Cars (long run) Affected by price changes Slightly affected by price changes
3. 3. Determine the price elasticity of demand for the diagram below, assuming that \$6 was our initial price. Is this elastic or inelastic? Quantity Demanded D \$6 100 \$3 140 Total Revenue
4. 4. Elasticity Price (\$) Quantity Demanded D 10 5 20 Now determine the PED for this diagram, Assuming that we started at \$7. Evaluate whether or not the company should have raised its prices. 7
5. 5. Elasticity – the concept <ul><li>The responsiveness of one variable to changes in another </li></ul><ul><li>When price rises, what happens to demand? </li></ul><ul><li>Demand falls </li></ul><ul><li>BUT! </li></ul><ul><li>How much does demand fall? </li></ul>
6. 6. Elasticity <ul><li>Price Elasticity of Demand </li></ul><ul><ul><li>The responsiveness of demand to changes in price </li></ul></ul><ul><ul><li>Where % change in demand is greater than % change in price – elastic </li></ul></ul><ul><ul><li>Where % change in demand is less than % change in price - inelastic </li></ul></ul>
7. 7. Elasticity The Formula: Ped = % Change in Quantity Demanded ___________________________ % Change in Price If answer less than 1: the relationship is inelastic If the answer is greater than 1: the relationship is elastic
8. 8. Determinants of Elasticity <ul><li>Time period – the longer the time under consideration the more elastic a good is likely to be </li></ul><ul><li>Number and closeness of substitutes – the greater the number of substitutes, the more elastic </li></ul><ul><li>The proportion of income taken up by the product – the smaller the proportion the more inelastic </li></ul><ul><li>Luxury or Necessity - for example, addictive drugs </li></ul>
9. 9. 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.
10. 10. 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
11. 11. 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
12. 12. 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!
13. 13. Elasticity <ul><li>If demand is price elastic: </li></ul><ul><li>Increasing price would reduce TR (%Δ Qd > % Δ P) </li></ul><ul><li>Reducing price would increase TR </li></ul><ul><li>(%Δ Qd > % Δ P) </li></ul><ul><li>If demand is price inelastic: </li></ul><ul><li>Increasing price would increase TR </li></ul><ul><li>(%Δ Qd < % Δ P) </li></ul><ul><li>Reducing price would reduce TR (%Δ Qd < % Δ P) </li></ul>
14. 14. Elasticity Last year, the price for tuition at a state university increased by 14%. As result of the price hike, the university saw an 8% drop in student enrollment. EVALUATE whether the university should raise prices, or lower prices next year if it would like to generate more revenue? Do this on your own. If you try to help someone around you, you will lose points for your class.
15. 15. Elasticity The price of product X has gone up from \$2 to \$3. As a result, the quantity demanded for product Y has gone up from 40 to 80. 1. First, graph this change on a demand diagram. 2. Determine the Cross Elasticity of Demand. 3. Explain whether products X and Y are complements or substitutes? How do we know? 4. Are these two goods elastic or inelastic? You may work together in your groups on this.
16. 16. Elasticity <ul><li>Cross Price Elasticity: </li></ul><ul><li>The responsiveness of demand of one good to changes in the price of a related good – either a substitute or a complement </li></ul>Xed = % Δ Qd of good t __________________ % Δ Price of good y
17. 17. Elasticity <ul><li>Goods which are complements : </li></ul><ul><ul><li>Cross Elasticity will have negative sign (inverse relationship between the two) </li></ul></ul><ul><li>Goods which are substitutes : </li></ul><ul><ul><li>Cross Elasticity will have a positive sign (positive relationship between the two) </li></ul></ul>
18. 18. Elasticity <ul><li>Income Elasticity of Demand: </li></ul><ul><ul><li>The responsiveness of demand to changes in incomes </li></ul></ul><ul><li>Normal Good – demand rises as income rises and vice versa </li></ul><ul><li>Inferior Good – demand falls as income rises and vice versa </li></ul>
19. 19. Elasticity <ul><li>Income Elasticity of Demand: </li></ul><ul><li>A positive sign denotes a normal good </li></ul><ul><li>A negative sign denotes an inferior good </li></ul><ul><ul><li>Examples: ramen noodles, bus fare, canned goods </li></ul></ul>
20. 20. Elasticity <ul><li>Problem #1: </li></ul><ul><ul><li>Your income increases by 3% which leads to demand falling by 1.8% for a certain product. </li></ul></ul><ul><ul><li>What is the YED? </li></ul></ul><ul><ul><li>Is this product normal or inferior? </li></ul></ul><ul><ul><li>Is it elastic or inelastic? </li></ul></ul>
21. 21. Elasticity <ul><li>For example: </li></ul><ul><li>Yed = - 0.6: Good is an inferior good but inelastic – a rise in income of 3% would lead to demand falling by 1.8% </li></ul><ul><li>Yed = + 0.4: Good is a normal good but inelastic – a rise in incomes of 3% would lead to demand rising by 1.2% </li></ul><ul><li>Yed = + 1.6: Good is a normal good and elastic – a rise in incomes of 3% would lead to demand rising by 4.8% </li></ul><ul><li>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% </li></ul>
22. 22. Elasticity <ul><li>Because of the current economic crisis, your employer has decided to cut your salary by 3%. Because of your pay cut, you decide to decrease your spending at Bembos by 4.8%. </li></ul><ul><li>First of all, determine the YED: </li></ul><ul><li>Is Bembo’s income elastic or inelastic? </li></ul><ul><li>Is Bembo’s a normal good or an inferior good? </li></ul>
23. 23. Elasticity <ul><li>Price Elasticity of Supply: </li></ul><ul><ul><li>The responsiveness of supply to changes in price </li></ul></ul><ul><ul><li>If Pes is inelastic - it will be difficult for suppliers to react swiftly to changes in price </li></ul></ul><ul><ul><li>If Pes is elastic – supply can react quickly to changes in price </li></ul></ul>Pes = % Δ Quantity Supplied ____________________ % Δ Price
24. 24. Elasticity <ul><li>Problem: </li></ul><ul><ul><li>We know that the original price of a good is \$9 and the new price is \$10. </li></ul></ul><ul><ul><li>At \$9 the quantity supplied is 150 and when the price is \$10 it is 210. </li></ul></ul><ul><ul><li>What is the PES? </li></ul></ul><ul><ul><li>Is it elastic or inelastic? </li></ul></ul>
25. 25. Elasticity <ul><li>Copy down these formulas together. Do you see a pattern? </li></ul>Ped = % Δ Quantity Demanded ____________________ % Δ Price Yed= % Δ Quantity Demanded ____________________ % Δ Income Pes = % Δ Quantity Supplied ____________________ % Δ Price Xed = % Δ Quantity Demanded x ____________________ % Δ Price of y
26. 26. Elasticity <ul><li>Write down the following elasticities and explain what they tell us. </li></ul>Ped = .8 Yed= - 1.9 Pes = 3.4 Xed = - .7
27. 27. Determinants of Elasticity <ul><li>What are some similarities between the determinants of elasticity of supply, and elasticity of demand? </li></ul><ul><li>What are some differences? </li></ul>
28. 28. Determinants of Elasticity (Supply) <ul><li>Time period – the longer the time under consideration the more elastic a good is likely to be </li></ul><ul><li>Closeness of producer substitutes – if a producer can produce several goods, each good is more elastic in terms of price changes </li></ul><ul><li>Unused capacity – if a producer is operating at full capacity, it will be harder to adjust to price increases, making it inelastic. However, it will be able to respond to decreases in price easier. </li></ul>
29. 29. Importance of Elasticity <ul><li>Relationship between changes in price and total revenue </li></ul><ul><li>Importance in determining what goods to tax (tax revenue) </li></ul><ul><li>Importance in analysing time lags in production </li></ul><ul><li>Influences the behaviour of a firm </li></ul>