Post on 15-Apr-2017
PRICE SYSTEM
Prepared by:
Prof. Ali Fallahchay
Learning Outcomes
• Price Elasticity of Demand and Types of Elasticity
• Calculating Elasticities: Arc, Point, Cross-price, Income and Supply
• Elasticity and Total Revenue
• Determinants of Demand Elasticity
Price Elasticity• Elasticity – measures the degree of responsiveness in the
quantity per unit of time to a change in any one of the factors of demand or supply.
• Price Elasticity – measures the relative responsiveness in quantity demanded to a change in price.
= - Q2 – Q1 x P1
P2 – P1 Q1
Elastic Demand Diagram
>1
Inelastic of demand
<1
Unit-elastic or Unitary
Perfectly Elastic
𝑒𝑑=∞
Perfectly inelastic
𝑒𝑑=0
Question and Answer
Q1: At a price of Php11.00, quantity demanded is 90; and at a price of Php9.00, quantity demanded is 110. The price elasticity of demand is:a. 0.1b. -0.82c. -1.22d. -1e. 0
Interpretation of Elasticity of Demand
• Ed > 1 demand is elastic
• Ed = 1 demand is unit elastic
• Ed < 1 demand is inelastic
• Extreme cases• Perfectly inelastic• Perfectly elastic
LO1
Arc Elasticity
𝑒𝑝=¿
│(Q2 – Q1) x (P2 + P1)│ │(P2 - P1) (Q2 + Q1)│
Example 1:Point Px Qx
A 16 0
B 14 2000
C 12 4000
D 10 6000
F 8 8000
G 6 10000
H 4 12000
L 3 14000
M 0 16000
Question and Answer
Q2:Find the 𝑒𝑝 for a movement from point B to point C
Q3:Find the 𝑒𝑝 for a movement from point C to point D
Total Revenue Test
• Total Revenue = Price X Quantity• Inelastic demand
• P and TR move in the same direction• Elastic demand
• P and TR move in opposite directions
LO2
Price Elasticity of demand and Total RevenueP Q TR = P x Q
10 1 10
9 2 18
8 3 24
7 4 28
6 5 30
5 6 30
4 7 28
3 8 24
2 9 18
1 10 10
Example 2
Total Revenue Test
LO2
$3
2
1
0 10 20 30 40 Q
P
a
bD1
• Lower price and elastic demand• Blue gain exceeds orange loss
Total Revenue Test
LO2
$4
3
2
1
0 10 20 Q
P
c
d
D2
• Lower price and inelastic demand• Orange loss exceeds blue gain
Total Revenue Test
LO2
$3
2
1
0 10 20 30 Q
P
e
fD3
• Lower price and unit elastic demand• Blue gain equals orange loss
Price Elasticity and Total RevenueELASTICITY IMPLICATIONS
Elastic As price decreases, quantity demanded and total revenue increases.
Inelastic As price decreases, quantity demanded increases, but total revenue decreases
Unitary As price decreases, the increase in quantity demanded exactly offsets it, and total revenue is constant
Cross Elasticity of Demand
• Measures responsiveness of sales to change in the price of another good
• Substitutes – positive sign• Complements – negative sign• Independent goods - zero
LO4
Percentage change in quantity demanded of product X
Ex,y = Percentage change in price of product Y
Cross Elasticity of Demand
• Application
• Change the price?
• Allow a merger?
LO4
Cross Elasticity
x
Before After
Commodity P Q P QProduct Y 80 600 60 800
Product X 40 400 40 300
Product Z 100 20 120 18
Product X 40 400 40 360
CROSS ELASTICITY OF DEMAND
ELASTICITY Category of Goods
INTERPRETATION
Positive Substitute Goods are substitutes for one another
Negative Complements Goods are consumed together
Zero Independents Goods are not related in consumption
Income Elasticity of Demand• Measures responsiveness of buyers
to changes in income • Normal goods – positive sign• Inferior goods – negative sign
LO4
Percentage change in quantity demanded
Ey = Percentage change in income
Simplified formula
ey =
ey =
x
ELASTICITYODS CATEGORY OF GOODS
INTERPRETATION
Positive Superior Consumption of the good varies directly with income
Negative Inferior Consumption of the good varies inversely with income
Zero Independent Consumption of the good does not vary with income
Price Elasticity of Supply
• Measures sellers’ responsiveness to price changes• Elastic supply, producers are
responsive to price changes• Inelastic supply, producers are not
responsive to price changes
LO3
Price Elasticity of Supply
• Formula to compute elasticity• Es > 1 supply is elastic• Es < 1 supply is inelastic
LO3
Percentage Change in QuantitySupplied of Product X
Percentage Change in Priceof Product X
Es =
Price Elasticity of Supply
• Time is primary determinant of elasticity of supply
• Time periods considered• Market period• Short Run• Long Run
LO3
Elasticity of Supply: The Market Period
LO3
P
Q
• Perfectly inelastic supply
D1
D2
Sm
Q0
Pm
P0
Elasticity of Supply: The Short Run
LO3
• Supply is more elastic than in market period
P
QD1
D2
Ss
Q0
Ps
P0
Qs
Elasticity of Supply: The Long Run
LO3
• Supply is even more elastic than in the short run
P
QD1
D2
Sl
Q0
Pl
P0
Ql
Applications of Elasticity of Supply
• AntiquesInelastic supply
• ReproductionsMore elastic supply
• Volatile gold pricesInelastic supply
LO3