2. Price Elasticity of Demand
β’ Law of demand tells us that price and quantity demanded are
inversely related.
β’ But it does not tell us by what percentage quantity demanded
changes as price changes.
β’ Price elasticity of demand helps to answer this question.
3. Both graphs are downward sloping but in
the first graph quantity demand is more
responsive to price change.
4. Formula for calculating price elasticity of
demand
β’ The price elasticity of demand is computed as the percentage change
in the quantity demanded divided by the percentage change in price.
β’ πΈ π =
πππππππ‘πππ πβππππ ππ ππ’πππ‘ππ‘π¦ ππππππππ
πππππππ‘πππ πβππππ ππ πππππ
=
% β π π
% β π
5. Calculating elasticity of demand
a) To calculate your change in quantity bought: New quantity β Original
quantity
b) % change in quantity bought is therefore: (Change in quantity/Average
quantity) x 100%
c) To calculate the change in price: New price β Original price
d) % change in price is therefore: (Change in price/Average price)
% change in quantity bought
Price elasticity of demand = -----------------------------------
% change in price
6. Practical illustration exercise:
β’ Decide on an item costing $1.00 that you and your friend often
Assume that at $1.00 you and your friend normally will buy one
Snicker Bar each.
β’ And when the price drops by 40 cents you by β¦β¦β¦β¦β¦β¦bars instead.
β’ Your friend reacts differently to the same reduction in price by
indicating that she will buy only β¦β¦β¦β¦β¦β¦β¦..bars.
β’ Letβs calculate the difference in the response between you and your
friend to the same change in price.
7. Examples
β’ Example 1: Suppose the price of computers rises by 10 percent. As a result
quantity demanded for the computers falls by 20 percent. Then the price
elasticity of demand is:
β’ πΈ π =
πππππππ‘πππ πβππππ ππ ππ’πππ‘ππ‘π¦ ππππππππ
πππππππ‘πππ πβππππ ππ πππππ
=
β’ Example 2: Suppose the price of cars rises by 10 percent. As a result
quantity demanded for the cars falls by 40 percent. The price elasticity of
demand is:
β’ πΈ π =
πππππππ‘πππ πβππππ ππ ππ’πππ‘ππ‘π¦ ππππππππ
πππππππ‘πππ πβππππ ππ πππππ
=
β’ Comparing example 1 and 2, it can be said that in these examples, quantity
demanded for β¦β¦β¦β¦β¦.are more responsive to changes in price.
8. Point Price Quantity
demanded
Change in price
(absolute)
Change in quantity
demanded
(absolute)
A 12 50
B 10 100 2 50
C 8 150
D 6 200
E 4 250
Example
Calculate the elasticity of demand
Between point A and B=
(100β50)/75
(12β10)/11
β 100
Between point B and C=
Between point C and D=
Between point D and E=
Elasticty
9. Elasticity is not slope
Example:
Point Price Quantity
demanded
Change in
price
Change in
price
(absolute)
Change in Qd Change in quantity
demanded
(absolute)
A 12 50
B 10 100 10-12= -2 2 100-50 =50 50
10. Graphical presentation
Price
Elasticity between A and B is 3.67
12 A
10 B Slope at Point A = -0.04
50 100 Quantity
β’Calculate elasticity and slope. You will see they are different.
Point Price Quantity
demanded
Change in price Change in quantity demanded
A 12 50
B 10 100 -2 50
C 8 150
D 6 200
E 4 250
11. From Perfectly Elastic to Perfectly Inelastic
Demand
β’ In economics, the price elasticity of demand measures the responsiveness of the quantity
demanded of a good to change in its price. The formula used to calculate the price elasticity of
demand is:
πΈ π =
πππππππ‘πππ πβππππ ππ ππ’πππ‘ππ‘π¦ ππππππππ
πππππππ‘πππ πβππππ ππ πππππ
β’ Unitary Elastic: If the value obtained by the formula is equal to 1.
β’ Elastic: If the value obtained by the formula is greater than 1, demand is said to be elastic.
β’ Inelastic: If the value obtained by the formula is less than 1, demand is said to be inelastic.
12. E = 1
0 Quantity
Price
100
1. A 22% increase
in priceβ¦
$5.00
2. β¦ Leads to a 22% decrease
in quantity demanded.
Demand
$4.00
80
Unit Elastic Demand
13. E > 1
0 Quantity
Price
100
1. A 22% increase
in priceβ¦
$5.00
2. β¦ Leads to a 67% decrease
in quantity demanded.
Demand
$4.00
50
Elastic Demand
14. E < 1
0 Quantity
Pric
e
100
1. A 22% increase
in priceβ¦
$5.00
2. β¦ Leads to a 11% decrease
in quantity demanded.
Demand
$4.00
90
Inelastic Demand
15. Perfectly Elastic and Perfectly Inelastic
β’ Think about the
demand curve of
medicine.
β’ The demand curve
faced by a
competitive firm is
horzonatal.
17. So what do we do with these values?
β’ Well, they are more useful to sellers than for consumers.
β’ If a seller knows how consumers respond to different prices for its
product, it is able to adjust the price in order to get the most sales
revenue.
β’ Knowing elasticity helps because it tells the seller whether the total
sales revenue will stay the same or go up or down when price
changes.
18. Total Revenue and Elasticity
β’ Total revenue of a seller equals the price of a good times the quantity
of the good sold.
β’ For example, if the burger seller stands down the street sells 100
burgers today at $1.50 each, its total revenue is $150.
β’ Suppose the burger vendor raises the price of hamburgers to $2 each.
What do you predict will happen to total revenue?
20. Price
Quantity0 80
Demand
$5.00
P x Q = $400
(revenue)
P x Q = $200
(revenue)
$2.00
100
How Total Revenue Changes When Prices Changes:
Inelastic Demand
22. Practice Question
When orange growers have a good harvest, they are faced with an oversupply of oranges. The growers
want to sell them quickly, so they drop their price of oranges, say from 20 cents a pound to 10 cents a
pound. Farmers figure that they will get a lot of new customers. People who normally don't drink orange
juice will switch to OJ when they see how low the prices are. But, to the farmers' surprise, they don't get a
lot more customers (not much increased demand for oranges).
In fact, the farmers find out that, if they just destroy most of the oranges instead of selling them on the
open market, the supply of oranges becomes scarce (limited). Farmers can then actually raise the price of
oranges, say from 20 cents a pound to 40 cents a pound. The farmers may lose a few customers, but most
of the customers still buy at the higher price, and farmers make more total revenue.
a) Is the above example of changing orange prices an example of highly elastic or highly inelastic demand
for oranges?
b) If you have a lot of competitors in your area, selling the same product as you are, will demand for that
product probably be highly elastic or highly inelastic? Why? How are competition and elasticity related?
23. Elastic Demand and Revenue
Price Price
11 11
7
10 Quantity demanded 10 40 Quantity demanded
Total revenue = P x Q = 11 x 10 =110 Total revenue = 7 x 40 =280
Decrease in TR due to decrease in price = 10 x (11 - 7) =40
Increase in TR due to increase in quantity = 7 x ( 40 -10 ) = 210
Net increase in TR = 210 - 40 = 170
Conclusion: if the demand curve is elastice decreases in price
leads to an increase in the Total revenue.
24. Inelastic Demand and Revenue
Price When P =11, TR=11 x10 =110
When P =7, TR=7 x15 =105
11
Decreasein revenuedueto decreasein price=(11 - 7 ) x10 =40
Increasein revenuedueto increasein quantity demanded =7 x(15 -10) =35
Neteffect:Decreasein revenu by $ 5
7
Conclusion:if thedemand curveis inelasticeadecreasein price
leads to adecreasein thetotalrevenue.
10 15 Quantity demanded
25. Elasticity of Demand and Revenue: Summary
Ed > 1 Price β Qd β % β Qd > % β P Increase in revenue due to increase in price
is less than the decrease in revenue due to
decrease in quantity demanded
TR β
Ed > 1 Price β Qd β % β Qd > % β P Decrease in revenue due to decrease in
price <the increase in revenue due to an
increase in quantity demanded
TR β
Ed <1 Price β Qd β % β Qd < % β P Increase in revenue due to increase in price
> decrease in revenue due to decrease in
quantity demanded
TR β
Ed < 1 Price β Qd β % β Qd < % β P Decrease in revenue due to decrease in
price < increase in revenue due to an
increase crease in quantity demanded
TR β
26. Price
Quantity2 4 6 8 10 120
6
5
4
3
2
1
7
14
Elasticity is
larger than
1.
Elasticity is
smaller
than 1.
Elasticity and Total Revenue along a Linear Demand Curve
Elasticity of demand at a point =
27. Determinants of Price Elasticity of Demand
The four factors that are relevant to the determination of price
elasticity of demand are:
1. number of substitutes,
2. necessities versus luxuries,
3. percentage of oneβs budget spent on
the good, and
4. time.
Please read in details from the textbook.
28. Other Elasticity Concept
β’ Cross Elasticity of Demand: A measure of the responsiveness in quantity demanded of one good
to changes in the price of another good.
Ec= Percentage change in quantity demanded of one good/ Percentage change in
price of another good
Ec can be positive, negative or zero
Ec> 0 Substitute Good
Ec<0 Compliments Good
β’ Income Elasticity of Demand
Ey= Percentage change in quantity demanded of one good/ Percentage change in income
Ey > 0 β Normal good
Ey < 0 β Inferior good
β’ Price elasticity of Supply: Percentage change in quantity supplied due to percentage change in
price
29.
30. Concept of Elasticity is Important for Tax
Imposition β¦
β’ There is a difference between the placement and the payment of a tax. For example, a tax may be
placed on the seller of a good, and both the seller and buyer end up paying the tax.
β’ Let us discuss a per-unit tax that was placed on the seller of a specific good (DVDs). This tax
shifted the supply curve of DVDs leftward. The vertical distance between the old supply curve
(before the tax) and the new supply curve (after the tax) was equal to the per-unit tax.
β’ If a per-unit tax is placed on the seller of a good, both the buyer and the seller will pay part of the
tax if the demand curve is downward sloping and the supply curve is upward sloping.
β’ The more inelastic the demand is, the larger the percentage of the tax is that the buyer will pay.
β’ The more elastic the demand, the smaller the percentage of the tax is that the buyer will pay.
