2. WHAT IS ELASTICITY?
Measure of just how much the quality demanded
will be affected by a change in price or change in
price of related goods.
2 significant words:
1. Measure- refers to as numbers or coefficients
2. responsiveness- refers to the reaction to change
3. 4 basic types of elasticity:
1. Price elasticity of demand
2. Price elasticity of supply
3. Income elasticity of demand
4. Cross elasticity
4. Types of Elasticity
- measures the responsiveness of quantity demanded of a good to a
change in the price.
1. Price elasticity of demand
How price elasticity is measured
5. Note: The price elasticity of demand is not the same
as the slope of a demand curve.
21
21
21
21
21
21
21
21
2
2
%
%
QQ
PP
PP
QQ
QQ
PP
PP
QQ
P
Q D
D
8. Ex: 1. Assumes that when gas prices increase by 50%, gas
purchased fall by 25%.
PED=
(−25%)
(50%)
= -0.50
9. Demand is elastic when the percentage change in quantity
demanded is greater than the percentage change in price.
Elastic if demand changes a lot when the price changes.
The price elasticity is greater than one in absolute value.
A decrease in price leads to an increase in total revenue.
An increase in price leads to a decrease in total revenue.
THE PRICE ELASTICITY OF DEMAND AND ITS
MEASUREMENT
1. Elastic Demand:
10. ELASTICITY
Price (P)
Quantity Demanded
D
10
5 20
Producer decides to reduce price to increase sales
7
% Δ in Price = - 30%
% Δ in Demand = + 300%
Ped = - 10 (Elastic)
Total Revenue rises
Good Move!
11. Demand is inelastic when the percentage change in quantity
demanded is less than the percentage change in price.
The price elasticity is less than one in absolute value.
A decrease in price leads to a decrease in total revenue.
An increase in price leads to an increase in total revenue.
THE PRICE ELASTICITY OF DEMAND AND ITS
MEASUREMENT
2. Inelastic demand
12. ELASTICITY
Price (P)
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. -Demand is unit elastic when the percentage change in
quantity demanded is equal to the percentage change in
price.
The price elasticity is equal to one in absolute value.
THE PRICE ELASTICITY OF DEMAND AND ITS
MEASUREMENT
3. Unit elastic demand
14. -the total amount of funds received by a seller of a good or service.
Total revenue is found by multiplying price per unit by the number of
units sold.
WHAT DETERMINES PRICE ELASTICITY OF
DEMAND?
Total Revenue
15. 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.
P5
100
Total revenue is price x quantity sold. In this example,
TR = P5 x 100,000 = P500,000.
This value is represented by the grey shaded
rectangle.
Total Revenue
16. Elasticity
Price
Quantity Demanded (000s)
D
If the firm decides to decrease price to (say) P3,
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.
P5
100
P3
140
Total Revenue
18. Types of Elasticity
2. Cross elasticity
- measures the responsiveness of quantity demanded by
changes in price of another good.
19. • CROSS PRICE ELASTICITY WILL BE POSITIVE WHEN THE TWO GOODS
ARE SUBSTITUTES IN CONSUMPTION.
• CROSS PRICE ELASTICITY WILL BE NEGATIVE WHEN THE TWO GOODS
ARE COMPLEMENTS IN CONSUMPTION.
24. CROSS PRICE ELASTICITIES
Would you expect the cross price elasticity between the
following pairs of goods to be positive or negative? Explain your
answers.
a) Coke and Pepsi.
b) DVD players and DVDs.
c) Gucci sunglasses and vegemite
25. CROSS PRICE ELASTICITIES
Solving the problem:
STEP 1: Review the material. The problem is about cross price
elasticities of demand, covered on 109 – 110 of the text.
STEP 2: Solving (a). Coke and Pepsi are the classic example of
two goods which are substitutes in consumption. An increase in
the price of Coke would, therefore, lead to an increase in
demand for Pepsi, so the cross-price elasticity would be positive.
26. CROSS PRICE ELASTICITIES
Solving the problem:
STEP 3: Solving (b). DVD players and DVDs are complements in
consumption. An increase in the price of DVD players would see
a decrease in demand for DVD players, and hence a decrease in
demand for the complement DVDs. The cross-price elasticity
between the two goods would, therefore, be negative.
27. Cross price elasticities
Solving the problem:
STEP 4: Solving (c). Gucci sunglasses and vegemite are completely
unrelated goods, therefore, we would expect the cross price
elasticity to equal zero.
