Download to read offline
More Related Content
Similar to price.pptx.......................................
price.pptx.......................................
- 1. PRICE ELASTICITY OFDEMAND
- 2. PRICE ELASTICITY OFDEMAND
- 3. Concept of Elasticityof Demand: The law of demand indicates the direction of change in quantity demanded to a change in price. It states that when price falls, demand rises. But how much the quantity demanded rises (or falls) following a certain fall (or rise) in prices cannot be known from the law of demand. That is to say, how much quantity demanded changes following a change in the price of a commodity can be known from the concept of elasticity of demand? Price elasticity of demand is an economic measure of the change in the quantity demanded or purchased of a product in relation to its price change. “Technical term which is employed to measure the proportional change in quantity demand as a result of proportional change in price.” Mathematically speaking: “ If we divide the marginal demand function (by the average demand function (Q/P), we will get elasticity of demand.”
- 4. PRICE ELASTICITY OFDEMAND • HOW TO FIND • HOW TO FIND
- 5. PRICE ELASTICITY OFDEMAND • IF INCOME INCREASE BY 1% THEN CONSUMPTION INCREASE 0.68%. • IF INCOME INCREASE BY 10% THEN CONSUMPTION INCREASE BY 6.8%. • IF INCOME DECREASE BY 10% THEN CONSUMPTION DECREASE BY 6.8%. • ELASTICITY HAS MAGNITUDE AND SIGN
- 6. PRICE ELASTICITY OFDEMAND • IF PRICE INCREASE BY 10% THEN DEMAND DECREASE BY 25%. • IF PRICE DECREASE BY 10% THEN DEMAND INCREASE BY 25%.
- 7. FORMULA OF PRICEELASTICITY OF DEMAND • ---
- 8. INTERPRETATION OF ELASTICITY •IF PRICE INCREASE BY 10% THEN DEMAND DECREASE BY 15%. • IF PRICE DECREASE BY 10% THEN DEMAND INCREASE BY 15%. • IF PRICE INCREASE BY 10% THEN DEMAND DECREASE BY 5%. • IF PRICE DECREASE BY 10% THEN DEMAND INCREASE BY 5%. • IF PRICE INCREASE BY 10% THEN DEMAND DECREASE BY 2.5%. • IF PRICE DECREASE BY 10% THEN DEMAND INCREASE BY 2.5%.
- 9. Price elasticity ofdemand: Price elasticity of demand measures the percentage change in quantity demanded resulting from one percentage change in price P Q 10 25 12 20 Q=5 P=2 = × = =1
- 10. Now change theposition of value the table: P Q 12 20 10 25 Q=-5 P=2 = × = =-3/2 Classical criticizing that
- 11. PRICE ELASTICITY OFDEMAND MOST APPROPRIATE FORMULA TO CALCULATE P Q 10 25 12 20
- 12. The most appropriateformula to calculate price elasticity of demand ( _ ^ ) 𝐸 𝑑 𝑝 is the midpoint formula, which ensures consistency and avoids bias based on whether we consider an increase or decrease. The formula is: price elasticity of demand Numerator (Change in Quantity as a Percentage of the Average Quantity) =Initial quantity demanded. New quantity demanded. =Midpoint (average) of the two quantities.
- 13. Now change theposition of value the table: P Q 12 20 10 25
- 14. INTERPRETATION OF CO-EFFICIENTOF PRICE ELASTICITY OF DEMAND: Negative sign (-) shows us about the relationship between price and quantity demanded. -11/9 tell us if price increase by 1% then quantity demanded will decrease by 11/9% and vice versa.
- 15. TYPES OF PRICEELASTICITY OF DEMAND: 1) Perfectly Elastic Demand 2) Elastic Demand 3) Unit Elastic Demand 4) Inelastic Demand 5) Perfectly Inelastic Demand
- 16. Perfectly Inelastic Demand(Edp=0): Meaning: Quantity demanded does not change regardless of price changes. Example: Life-saving medications or essential utilities where people must purchase regardless of cost. Graph: The demand curve is a vertical line.
- 17. CHAPTER 5 ELASTICITYAND ITS APPLICATION Q1 P1 D “PERFECTLY INELASTIC DEMAND” (ONE EXTREME CASE) P Q P2 P falls by 10% Q changes by 0% 0% 10% = 0 Price elasticity of demand = % change in Q % change in P = Consumers’ price sensitivity: D curve: Elasticity: vertical 0 0
- 18. Inelastic Demand (Edp<1): Meaning:The percentage change in quantity demanded is smaller than the percentage change in price. Example: Necessities like salt, bread, or fuel, where people keep buying despite price changes. Graph: The demand curve is relatively steep.
- 19. CHAPTER 5 ELASTICITYAND ITS APPLICATION D “INELASTIC DEMAND” P Q Q1 P1 Q2 P2 Q rises less than 10% < 10% 10% < 1 Price elasticity of demand = % change in Q % change in P = P falls by 10% Consumers’ price sensitivity: D curve: Elasticity: relatively steep relatively low < 1
- 20. Unit Elastic Demand(Edp=1): Meaning: The percentage change in quantity demanded equals the percentage change in price. Example: Products like restaurant meals where people adjust spending proportionally to price changes. Graph: A rectangular hyperbolic demand curve.
- 21. CHAPTER 5 ELASTICITYAND ITS APPLICATION D “UNIT ELASTIC DEMAND” P Q Q1 P1 Q2 P2 Q rises by 10% 10% 10% = 1 Price elasticity of demand = % change in Q % change in P = P falls by 10% Consumers’ price sensitivity: Elasticity: intermediate 1 D curve: intermediate slope
- 22. 2. Elastic Demand(Edp>1): Meaning: The percentage change in quantity demanded is greater than the percentage change in price. Example: Luxury goods, such as designer clothing or electronics, where people are more sensitive to price changes. Graph: The demand curve is relatively flat.
- 23. CHAPTER 5 ELASTICITYAND ITS APPLICATION D “ELASTIC DEMAND” P Q Q1 P1 Q2 P2 Q rises more than 10% > 10% 10% > 1 Price elasticity of demand = % change in Q % change in P = P falls by 10% Consumers’ price sensitivity: D curve: Elasticity: relatively flat relatively high > 1
- 24. 1. Perfectly ElasticDemand (Edp=∞): Meaning: Even a tiny change in price causes an infinite change in quantity demanded. Example: If the price of a product increases even slightly, nobody buys it; if the price drops slightly, everyone wants to buy it. Graph: The demand curve is a horizontal line.
- 25. CHAPTER 5 ELASTICITYAND ITS APPLICATION D “PERFECTLY ELASTIC DEMAND” (THE OTHER EXTREME) P Q P1 Q1 P changes by 0% Q changes by any % any % 0% = infinity Q2 P2 = Consumers’ price sensitivity: D curve: Elasticity: infinity horizontal extreme Price elasticity of demand = % change in Q % change in P =
- 26. Type of ElasticityElasticity Value (EdpEdp ) Sensitivity to Price Perfectly Elastic Demand Edp=∞ Very high Elastic Demand Edp>1 High Unit Elastic Demand Edp=1 Proportional Inelastic Demand Edp<1 Low Perfectly Inelastic Demand Edp=0 None
- 27. Cross elasticity ofdemand Definition: The cross elasticity of demand refers to the responsiveness of the quantity demanded of one good when the price of a related good changes. It's used to understand the relationship between two products and how changes in the price of one product affect the demand for the other. “The cross elasticity of demand is the proportional change in the quantity of X good demanded resulting from a given relative change in the price of a related good Y” Ferguson “The cross elasticity of demand is a measure of the responsiveness of purchases of Y to change in the price of X” Leibafsky
- 28. Types of CrossElasticity of Demand: 1. Positive: 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. 2. Negative: 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. Formula for Cross Elasticity of Demand:
- 29. 3. Zero: Cross elasticityof demand is zero when two goods are not related to each other. For instance, increase in price of car does not effect the demand of cloth. Thus, cross elasticity of demand is zero. Formula to calculate Ec: Ec > 0 Goods are substitute Ec < 0 Goods are complements Ec = 0 Goods are unrelated
- 30. Type of Cross ElasticityDescription Example Positive Cross Elasticity Goods are substitutes. An increase in the price of one good leads to an increase in demand for the other. Coffee and tea (if coffee price rises, more people buy tea). Negative Cross Elasticity Goods are complements. An increase in the price of one good leads to a decrease in demand for the other. Printers and ink cartridges (if printer price rises, fewer ink cartridges are bought). Zero Cross Elasticity Goods are unrelated. Price changes in one good have no effect on the demand for the other. Shoes and smartphones (changing shoe prices doesn’t affect smartphone demand).
- 31. Income elasticity ofdemand Consumer’s income is one of the important determinants of demand for a product. The demand for a product and consumer’s income are directly related to each other, unlike price-demand relationship. “Income elasticity of demand means the ratio of the percentage change in the quantity demanded to the percentage in income”-Watson. “Income elasticity of demand means the ratio of the percentage change in the quantity demanded to the percentage in income.”
- 32. Definition: Ey= percentage changein Qd/ percentage change in y Formula to calculate If Ey>0 Goods are normal Ey<0 Goods are inferior Ey=0 Goods are unrelated
- 33. Type of Income Elasticity Elasticity ValueExplanation Example Positive Income Elasticity Edi>0Edi >0 Demand increases as income increases. Normal Goods. Luxury goods, electronics, vacations. Negative Income Elasticity Edi<0Edi <0 Demand decreases as income increases. Inferior Goods. Instant noodles, second-hand clothes. Unitary Income Elasticity Edi=1Edi =1 Demand changes exactly in proportion to income changes. Normal Goods. Basic necessities, food. Perfectly Income Inelastic Edi=0Edi =0 Demand does not change as income changes. Essential medicines, basic utilities.
- 34. PRICE ELASTICITY ANDTOTAL REVENUE • Continuing our scenario, if you raise your price from $200 to $250, would your revenue rise or fall? Revenue = p x q • A price increase has two effects on revenue: • Higher P means more revenue on each unit you sell. • But you sell fewer units (lower q), due to law of demand. • Which of these two effects is bigger? It depends on the price elasticity of demand.
- 35. Elasticity and TotalRevenue • When elasticity is elastic than decrease prices leads to increase in total revenue and vice versa. • When elasticity is inelastic than increase prices leads to increase in total revenue and vice versa.
- 36. Marginal revenue andthe own price elasticity of demand • When elasticity elastic mean in absolute greater than 1 than marginal revenue positive. • When elasticity unitary elastic mean in absolute equal to 1 than marginal revenue zero. • When elasticity inelastic mean in absolute less than 1 than marginal revenue negative. • D
- 37. Price elasticity ofsupply measures how much the quantity supplied of a good changes when the price of that good changes. In simple terms, it shows how responsive producers are to price changes.
Editor's Notes
- #17 If Q doesn’t change, then the percentage change in Q equals zero, and thus elasticity equals zero. It is hard to think of a good for which the price elasticity of demand is literally zero. Take insulin, for example. A sufficiently large price increase would probably reduce demand for insulin a little, particularly among people with very low incomes and no health insurance. However, if elasticity is very close to zero, then the demand curve is almost vertical. In such cases, the convenience of modeling demand as perfectly inelastic probably outweighs the cost of being slightly inaccurate.
- #19 An example: student demand for textbooks that their professors have required for their courses. Here, it’s a little more clear that elasticity would be small, but not zero. At a high enough price, some students will not buy their books, but instead will share with a friend, or try to find them in the library, or just take copious notes in class. Another example: gasoline in the short run.
- #21 This is the intermediate case: the demand curve is neither relatively steep nor relatively flat. Buyers are neither relatively price-sensitive nor relatively insensitive to price. This is also the case where price changes have no effect on revenue.
- #23 A good example here would be Rice Krispies, or nearly anything with readily available substitutes. An elastic demand curve is flatter than a unit elastic demand curve (which itself is flatter than an inelastic demand curve).
- #25 “Extreme price sensitivity” means the tiniest price increase causes demand to fall to zero. “Q changes by any %” – when the D curve is horizontal, the quantity is indeterminant. Consumers might demand Q1 units one month, Q2 units another month, and some other quantity later. Q can change by any amount, but P always “changes by 0%” (i.e. doesn’t change). If perfectly inelastic is one extreme, this (perfectly elastic) is the other. Here’s a good real-world example of a perfectly elastic demand curve, which foreshadows an upcoming chapter on firms in competitive markets. Suppose you run a small family farm in Iowa. Your main crop is wheat. The demand curve in this market is downward-sloping, and the market demand and supply curves determine the price of wheat. Suppose that price is $5/bushel. Now consider the demand curve facing you, the individual wheat farmer. If you charge a price of $5, you can sell as much or as little as you want. If you charge a price even just a little higher than $5, demand for YOUR wheat will fall to zero: Buyers would not be willing to pay you more than $5 when they could get the same wheat elsewhere for $5. Similarly, if you drop your price below $5, then demand for YOUR wheat will become enormous (not literally infinite, but “almost infinite”): if other wheat farmers are charging $5 and you charge less, then EVERY buyer will want to buy wheat from you. Why is the demand curve facing an individual producer perfectly elastic? Recall that elasticity is greater when lots of close substitutes are available. In this case, you are selling a product that has many perfect substitutes: the wheat sold by every other farmer is a perfect substitute for the wheat you sell.
- #34 We return to our scenario. It’s not hard for students to imagine being in this position – running their own business and trying to decide whether to raise the price. To most of your students, it should be clear that making the best possible decision would require information about the likely effects of the price increase on revenue. That is why elasticity is so helpful, as we will now see….