The document discusses concepts related to demand, including consumer surplus, demand curves, price elasticity of demand, and income elasticity of demand. It provides definitions and formulas for calculating elasticities. Consumer surplus is defined as the benefit consumers receive above the market price they pay. Demand curves can be used to graphically represent consumer surplus. Price elasticity of demand measures the responsiveness of quantity demanded to changes in price. Income elasticity of demand measures the responsiveness of quantity demanded to changes in consumer income. The document also discusses factors that determine elasticities and the importance and uses of measuring elasticities.

1. Theory of
demand
Continued
Demand ppt #2

2. Consumer surplus
� It is the benefit that consumer receives over
and above that for which they actually pay .
� Example: Jadon places a personal value on
apples equal to $10.00,while the market price or
market value is $5.00, what is the consumer
surplus?
� $5.00

3. Consumer Surplus
� Consumer surplus is the difference
between the maximum price the
consumer was willing to pay and
what they actually paid
( i.e. the Market price)
� The concept of consumer surplus can be
shown graphically on a demand curve
� It is an area below the demand curve,
above the price line , and to the right of the
price axis.

4. Graph showing consumer
Surplus

5. The Theory of
Elasticity

6. Elasticity
� The three main determinants of
demand are price , income and price
of other goods.
� This gives rise to three main measures
of demand elasticity
1. Price elasticity of demand
2. Income elasticity of demand
3. Cross elasticity of demand

7. Definition of Elasticity
� Measures the degree to which
changes in the price of an item results
in change.
� Measures the degree to which
changes in the price of an item results
in changes in a unit supplied (elasticity
of supply) or a unit change
in demand (elasticity of demand). The
opposite of elasticity is inelasticity.

8. Price elasticity of demand
�Measures the degree of
responsiveness of quantity
demanded of a good to
changes in price.
Responsiveness may be great
(elastic), very little (inelastic)
or equal (unitary).

9. Cont.
�The category any particular
demand falls in depends upon
the relative percentage
change in price levels, the
quantity demanded and the
resultant effect upon total
revenues.

10. The categories of elasticity
� Elastic- If an increase in price of a
particular good causes a significant fall
in demand, the demand for that
product is said to be elastic
� For example , if price increase by 10 %
and demand decreases by 20%
demand would be elastic

11. Inelastic
If an increase in the price of a particular
good does not significantly affect the
demand for the product, then the
demand for such product would be
inelastic.
For example , if price increases by 10%
and demand falls by 8% demand would
be inelastic.

12. Unitary
� If the change in price for a particular
product, causes the same change in
quantity then the demand for such
product would be unitary.
� Example: 10% increase in price , causes
a 10% decrease in quantity demanded.

13. ARC Method -Formula:

14. Arc Formula
Percentage change:
Change in quantity =
� New Q – old Q * 100
Old Q
Change in price =
New Price - Old Price * 100
Old Price

15. Elasticity using the Midpoint
formula
Midpoint formula
Change /Average
x 100

16. Let us explore an example
Question 1
The price of apples increases from $150 per
bags to $250 per bag. As a result , the
demand for apples fall from 250 bags per
day - 200 bags.
From the data above , what would be the
price elasticity of demand ?
Interpret the result
a)Use the Arc formula
b)Use the midpoint formula

17. Question 2
� If the price of bun change from $ 900 to
$1900 and the quantity demanded
changes from 7 to 6. Calculate the price
elasticity of demand .
� Interpret the result
� Use ARC FORMULA FIRST AND THEN
CALCULATE USING THE MIDPOINT FORMULA

18. Question 3
� The price of bobby increase from $4 -
$5 and the quantity change from $3 -
2 .
� Calculate the Price elasticity of demand
using the Arc formula

19. Question 4
� The price of chocolate increase from
$5-$10 Quantity decreases from 20-10 .
Calculate the Price Elasticity of
demand?
� Using the Arc Formula

20. The coefficient / Interpretation of the
results
�If the 1< PED < ∞ then
demand is elastic.
✔ This means that percentage change in quantity is more
than proportionate to the percentage change in price
✔ If price falls by a given percentage , quantity increases by
a larger percentage. Total expenditure/ revenue increases
✔ If price increase by a given percentage, this is exceeded
by the percentage reduction in quantity. Total
expenditure/revenue falls.

21. Inelastic
Inelastic 0<PED<1 then demand is inelastic
✔ This means that the percentage change in quantity is
less than proportionate to the percentage change in
price.
✔If price falls by a certain percentage , then quantity
increases by a smaller percentage. Fall in total revenue
✔If price increase by a certain percentage , the quantity
demanded falls by a smaller percentage. Increase in total
revenue

22. Unitary
� PED = 1 then demand is unitary
✔ This means that the percentage change in
quantity is just proportionate to the percentage
change in price.
✔ This means that any price change is followed by
a proportionate quantity responses in the
opposite direction
✔ Consumer expenditure remain unaltered……

23. Perfectly inelastic and Perfectly
Elastic
� PED = 0
�Zero (0), which is perfectly
inelastic.
�PED = ∞
�Infinite (∞), which is perfectly
elastic.

24. Graded Class
Work

25. 2015 past paper
� Assume that the maximum amount
Lavona is willing to pay for a chocolate
bar is $5.00 and the current market price is
2.50 . At the price lavona is willing and
able purchase 6 chocolate bars. Draw
Lavona demand curve 4marks
� on the demand curve shade the total
consumer surplus. 2marks

26. Multiple choice questions
1. The slope of a demand curve depends on
a) the units used to measure quantity but not the units used to measure
price.
b) the units used to measure price and the units used to measure
quantity.
c) the units used to measure price but not the units used to measure
quantity.
d) neither the units used to measure price nor the units used to measure
quantity
2. The price elasticity of demand depends on
A) the units used to measure price but not the units used to measure
quantity.
B) the units used to measure price and the units used to measure
quantity.
C) the units used to measure quantity but not the units used to measure
price.
D) neither the units used to measure price nor the units used to measure
quantity

27. � The price elasticity of demand measures
� A) the slope of a budget curve.
� B) how often the price of a good
changes.
� C) the responsiveness of the quantity
demanded to changes in price.
� D) how sensitive the quantity demanded
is to changes in demand.

28. � 4. 10 percent increase in the quantity of spinach
demanded results from a 20 percent decline in its
price. The price elasticity of demand for spinach is
� A) 0.5.
� B) 20.0.
� C) 2.0.
� D) 10.0.

29. � 5. If the price elasticity of demand for a
product equals 1, as its price rises the
� A) total revenue increases.
� B) quantity demanded does not change.
� C) total revenue does not change.
� D) quantity demanded increases.

30. Show workings
A. Refer to Figure 5.3. Use the midpoint formula. If
the price of a garden burger is increased from
$8 to $10, the price elasticity of demand equals
________ and demand is ________.
B. A) 4.5; elastic
C. B) -0.5; inelastic
D. C) -4.5; elastic
E. D) -9.0; inelastic

31. � 8. When the price of leather increased
from $9 to $10 the quantity demanded
decreased from $150 unit to 110.
Calculate the elasticity of demand
using the (Arc method ) and interpret
the results (8 marks)
� Calculate Ped using the midpoint
formula

32. If the price of Bun changes from $900 to
$1900 and the QD changes from 7 to 6.
Calculate the price elasticity of demand

33. LESSON 2
❖The Graphs for Price Elasticity of demand
❖Total Revenue

34. Price Elastic Demand
� When the % change in price results in a greater
than proportionate % change in QD.
� A percentage decrease in price will bring about a
greater % expansion in QD which results in an
increase in total revenue and vice versa.
� The curve tends to be flat

36. Calculation of total revenue
Total revenue is the price
of an item multiplied by
the number of units sold:
TR = P x Qd.

37. Calculating Total Revenue
Example
� The Price for parking tickets increase from $40
to $48. Last year the college sold 12,800 student
parking passes. This year, at the new price, the
college sells 11,520 parking passes.
a) Calculate the Total Revenue
Year 1: 12,800 parking permits sold x $40 per permit
= $512,000
Year 2: 11,520 parking permits sold x $48 per permit
= $552,960

38. Total Revenue
� $552,960- $512,000 = $40,960
� The college earned an additional $40,960
in revenue.
� In this case, student demand for parking
permits is inelastic. A significant change in
price leads to a comparatively smaller
change in demand.
� The result is lower sales of parking passes
but more revenue.

39. Price inelastic demand
� A % change in price brings
about a smaller than
proportionate change in QD
so as to decrease total
revenue.
� The curve tends to be steep.

41. Price unitary demand
1. The % change in price results
in the exact percentage
change in QD leaving total
revenue unchanged.
1. The coefficient 1.

43. Perfectly Inelastic Demand
� Quantity demanded does not respond
to price changes
� the coefficient is zero
� the graph is a vertical line showing that
demand is fixed at all price levels
� eg. Gas, electricity and water

45. Perfectly Elastic Demand
� Demand is infinitely responsive to price
changes
� the coefficient is infinity
� the graph is a horizontal line
� at a fixed level the consumer demand
an infinite amount of the product. If
price increases demand will fall to 0, but
if price falls demand will increase to
infinity.

47. Classwork
� 1. When the price of chicken was $100,
900 was demanded. However, when the
price fell to $90, 1350 is demanded.
a)Calculate the change in revenue,
b)Calculate PED
c) Draw the demand curve
d)Name the category of elasticity.

48. 2. When the price of chicken back was
$100, 900 was demanded. However,
when the price fell to $90, 990 is
demanded.
Calculate the change in revenue,
Calculate PED
Draw the demand curve
Name the category of elasticity.

49. � When the price of bread was $100, 900
was demanded. However, when the
price fell to $90, 909 is demanded.
� Calculate the change in revenue,
� Calculate PED
� Draw the demand curve
� Name the category of elasticity.

50. All categories of elasticity of
demand

51. Lesson3

52. Factors Determining Price
Elasticity of Demand
✔ Degree of substitutability – elasticity is greater once
there are close substitutes. Gas is inelastic but
among the different stations it is elastic.
✔ Time – Over longer of time demand tends to be
more elastic as you can find more substitutes over a
longer period of time.

53. ✔Proportion of Income – the greater
the proportion of income spent on
a commodity (food) the greater
the price elasticity of demand.
✔Degree of necessity – the greater
the degree of necessity the lesser
the price elasticity of demand. Eg.
Water, gas and electricity.

54. � Addiction – the more addictive or habit forming a
product is the more inelastic the price elasticity of
demand. Eg. Alcohol and cigarettes.
� Compliments – demand tends to be inelastic
because some products cannot do without the
other (cars and tyres)

55. Importance/Uses of Price
Elasticity of Demand
1. Firms can predict the change in
revenue that will occur when price
changes. Therefore increase prices on
inelastic goods to make more revenues
and decrease them on elastic goods to
make more revenues.
2. Price Discrimination - Firms can charge
different prices in different markets
depending on the elasticity of demand.

56. 3. Firms can decide how much tax to pass
on to a consumer. They will pass on more
of the tax to goods with an inelastic
demand.
4. Government can predict the impact
taxation policies will have on certain
products. Reduce the tax on goods with
an elastic demand and increase the tax
on goods where the demand is inelastic in
order to increase tax revenues.

57. Income
Elasticity of
demand

58. Questions
�What is income
elasticity of
demand ?

59. Income Elasticity of Demand
• This measure the responsiveness of
quantity demanded to changes in
income.
• Formula:
Y

60. � We can express this as the
following:
� YED = (New Quantity Demand – Old
Quantity Demand) /(Old Quantity
Demand)
� / (New Income – Old Income)/(Old
Income)

61. Categories of Income Elasticity of
demand
• YED can be positive or negative.
1. Income elasticity - YED > 1
2. Income inelasticity - YED >0 and <1
3. Unitary income elasticity – YED = 1
4. Negative income elasticity - YED < 0
5. Zero income elasticity - YED = 0
Income Elasticity of Demand = 0 means that the
demand for the good isn’t affected by a change in
income.

62. Values of Income Elasticity
� Income elastic demand - Income
elasticity is greater than 1.
� A 1% change in income causes a greater
than 1% change in quantity demanded.
� These are called luxury goods, e.g. Rolex

63. �Income inelastic demand – Income
elasticity is between 0 and 1.
�A 1% change in incomes causes a
less than 1% change in quantity
demanded.
�As the quantity demanded doesn't
change a great deal in response to
income we can assume the good is a
necessity, e.g., food and clothes

64. • Negative income elasticity – YED< 0
• A change in income will bring about
an opposite change in quantity
demanded.
• If income increases the quantity
demanded will decrease.
• The good is described as inferior, e.g.,
bread.

65. Example
� Let’s take an example of a shop that sells widgets.
They estimate that when the average real income of
its customers falls from $60,000 to $40,000, the
demand for its widgets falls from 5,000 to 4,000 units
sold, with all other things remaining the same.
� Using the income elasticity of demand formula,
� YED = (New Quantity Demand – Old Quantity
Demand)/(Old Quantity Demand) / (New Income –
Old Income)/(Old Income)
� = (4,000 – 5,000)/(5,000) / (40,000-60,000)/(60,000)
� = 0.61

66. Now try one on your own
� Suppose consumer income increases
from $1000 to $1250 per month and
the quantity of tickets demanded
increases from 10,000 to 15000.
Compute YED. Is it a normal good or an
inferior good?

67. Question
� Samuel a bus driver income increased
from $30,000 to $32,000. His demand for
chicken changed from 50lbs to 20lbs.
� Calculate his income elasticity of demand
and state what type of goods chicken is.

68. LESSON 2

69. Income Elastic Goods
�Normal goods – demand
increases as income
increases and vice versa.
The elasticity is positive.
The coefficient is greater
than zero.

71. �- Luxury goods are normal and
are very sensitive to changes in
income. The income elasticity
> 1.
�Necessities are normal goods
but are not sensitive to
changes in income. The
income elasticity < 1.

72. �Inferior goods – demand
falls as income increases
and vice versa. The
elasticity is negative. The
coefficient is less than zero.
(response may be small or
big)

74. All Categories of Income
Elasticity

76. The importance of Income
Elasticity
� A growth in the economy means an increase in
income and a decrease in the demand for inferior
goods.
� Unemployment may occur because the demand
for necessary goods like food and clothing is not
rising fast enough.
� Goods with high income elasticity such as tourism
and computers may suffer when the economy is
not growing.

77. Uses of Income Elasticity
� Helps to determine which
goods to supply.
� Firms can estimate potential
changes in demand
� Firms can plan production and
employment requirements as
the economy grows or shrinks.

78. • Please see worksheet with multiple
choice questions

79. Cross Elasticity of
Demand

80. Cross Elasticity of Demand
�Measures the degree of
responsiveness of the
demand for one good
(X) to a change in the
price of another good
(Y).

81. Formula:

82. �

83. CED/XED
• Cross elasticity of demand is
used to determine substitute
good (+) and complementary
goods (-).
• Cross-price elasticity is positive
for substitutes but negative for
complements

84. Substitute, complementary,
independent
❖ When goods are substitute of each other then cross
elasticity of demand is positive. In other words, when
an increase in the price of Y leads to an increase in
the demand of X. For instance, with the increase in
price of tea, demand of coffee will increase.
❖ In case of complementary goods, cross elasticity of
demand is negative. A proportionate increase in
price of one commodity leads to a proportionate fall
in the demand of another commodity because both
are demanded jointly
❖ Unrelated products have a zero cross elasticity for
example the effect of changes in taxi fares on the
market demand for cheese!

85. For example: Coke
and Pepsi
For example: Bread
and Butter
For example: Bread
and Soda

86. Let us try this together
� The original price of the commodity Y is $8 and
the quantity demanded for the commodity X
stands at 80 units. Calculate the CED if the price
of Y changes to $12, with the demand for X
increasing to 100 units .
� What is the relationship between these two
commodities X and Y ?

87. The original price of the commodity Y is
$20 and the quantity demanded for the
commodity X stands at 80 units.
Calculate and interpret the value of CED
if after the price of Y increases to $40, with
the demand for X falls to 70 units

88. Uses of cross elasticity of
demand
� Firms can estimate the effect on the
demand for their product if their
competitor had a price cut or price
increase.
� Firms can estimate the impact on
demand for their product if there is a
decrease/increase in the price of a
complement.

89. Review questions
1. If the price of bread falls from $84 to $76
and the QD increases from 600 to700.
Calculate the elasticity of demand. Is
demand elastic, inelastic or unitary?
2. Jam prices increased from $1.20 to $1.50
and the QD decreased from 80,000 to
75,000. Calculate the elasticity of
demand. Is demand elastic, inelastic or
unitary?

90. 3. If the price of KFC decreases from $300 to $200
and the QD of burger falls from 800 to 500.
Calculate the elasticity of demand. Are the
goods substitutes, complements or
independent.
4. If income increases from $40,000 to $50,000 and
demand falls from 1000 to 800. Calculate the
elasticity of demand. Is the good a normal or
inferior good?

91. � The Price of chicken decreased from $300
to $200 resulting in the demand for chips
changing from 1000 to 800.
Calculate the cross elasticity of demand.
Are the goods substitutes or complements?

92. 5. A patty vendor discovered that if he
charged $80 for patty 450 is demanded,
but if he sells it for $60, 600 is sold.
Calculate the elasticity of demand. Is
demand elastic, inelastic or unitary?

93. The End
PRACTICE
BECOMES
PERFECT!!!