#8 ELASTICITY OF DEMAND.ppt

7/28/2019 #8 ELASTICITY OF DEMAND.ppt

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ELASTICITY OF DEMAND



MIDTERM EXAM

• THIS WEDNESDAY – MARCH 20

• ALL LECTURES THRU TODAY

• NO MAKE-UP OPPORTUNITY

• MCQs AND SHORT ANSWER



HOMEWORK #2



INCOMES IN CHINA INCREASE

• NORMAL GOOD • INFERIOR GOOD

D1

P

D2

D1

P

Sugar Chicken Feet

D2

S

Q1→Q2

P2

↑

P1

S

Q2←Q1

P1

↓

P2



TERRORISTS BLOW UP OIL

REFINERIES

• PETROL SUPPLY ↓ • CAR DEMAND ↓

D

P

D2

D1

P

Petrol Cars

S

Q2←Q1

P2

↑

P1

S

Q2←Q1

P1

↓

P2

S2



A GOOD TEA CROP

• TEA SUPPLY ↑ • COFFEE DEMAND ↓

D

P

D2

D1

P

Tea Coffee

S2

Q1 → Q2

P1

↓

P2

S

Q2←Q1

P1

↓

P2

S1



QUIZ



QUIZ

• A 20 ton solid gold meteor lands just

outside of Lahore. Use Demand and

Supply diagrams to show what will happen

to the Price of gold and the Quantity of gold purchased.



THE GOLDEN METEOR

• GOLD SUPPLY ↑ • The Supply of gold

will increase

• The Price of gold

will decrease

• The amount of gold

sold will increase

D

P

Gold

S2

Q1 → Q2

P1

↓

P2

S1



ELASTICITY OF DEMAND



WHAT IS THE DIFFERENCE BETWEEN THESE

TWO DEMAND CURVES?

P

Q

D1

D2




TWO DEMAND CURVES

• Both obey the Law

of Demand

D2

D1

P

Q




TWO DEMAND CURVES

• Both obey the Law of

Demand

• One is RED and one

is BLACK

D2

D1

P

Q




TWO DEMAND CURVES

• Both obey the Law of

Demand

• When Price

increases Quantitiesdecrease more on

D1 than on D2

D2

D1

Q2 Q0Q1

P

PNEW

P

Q




TWO DEMAND CURVES

• Both obey the Law of Demand

• When Price increases

Quantities decrease more on D1 than onD2

• When Price

decreasesQuantities increase more on D1 than onD2

D2

D1

Q0 Q2 Q1

P

PNEW

P

Q




TWO DEMAND CURVES

• On D1 the responseto a price change is alarger

• D1 represents amarket in whichbuyers are moresensitive to price

• In economics we callthis sensitivityElasticityD2

D1

Q

P



WHO CARES ABOUT

ELASTICITY?

• A business considering a price change

– How much will a price hike reduce our

sales?

– How many new customers will we get if we

have a sale?



WHO CARES ABOUT

ELASTICITY?


• A college considering a tuition hike



WHO CARES ABOUT

ELASTICITY?



• A forecaster trying to predict how lastweek’s rain will affect the price of grain.



WHO CARES ABOUT

ELASTICITY?



• A forecaster trying to predict how lastweek’s rain will affect the price of grain.

• A MPA trying to understand how

greater prison terms for arsonistswould reduce mob violence



WHO CARES ABOUT

ELASTICITY?



• A forecaster trying to predict how last week’s

rain will affect the price of grain.

• A MPA trying to understand how greater prison

terms for arsonists would reduce mob violence

• A Demographer trying to predict howexpected increases in women’s wages will

affect population growth and family size



MEASURING ELASTICITY

• Economists measure elasticity by

comparing

– The percentage change in Price with

– The percentage change in Quantity



THE COEFFICIENT OF

ELASTICITY

• For small changes in Price

η = %∆Q ÷ %∆P = ∆Q/Q ÷ ∆P/P

• For larger changes in Price

η = ∆Q/((Q1+Q

2)/2) ÷ ∆P/((P

1+P

2)/2)

This is called Arc Elasticity



THE COEFFICIENT OF

ELASTICITY

• If %∆Q > %∆P

η = %∆Q ÷ %∆P > 1

We say the Demand is Elastic



THE COEFFICIENT OF

ELASTICITY

• If %∆Q > %∆P

η = %∆Q ÷ %∆P > 1


If %∆Q < %∆P

η = %∆Q ÷ %∆P < 1

We say the Demand is Inelastic



THE COEFFICIENT OF

ELASTICITY

• If %∆Q > %∆P

η = %∆Q ÷ %∆P > 1


If %∆Q < %∆P η = %∆Q ÷ %∆P < 1

We say the Demand is Inelastic

If %∆Q = %∆P η = %∆Q ÷ %∆P = 1

We say the Demand is Unitary Elastic



DEFINITIONS

• Elastic

– Quantity Demanded is very responsive to price

η = %∆Q ÷ %∆P > 1

• Inelastic Quantity Demanded is not very responsive to price

η = %∆Q ÷ %∆P < 1

• Unitary Elastic

Quantity Demanded moves in proportion to price

η = %∆Q ÷ %∆P = 1



ELASTICITY AND TOTAL

EXPENDITURE

• We know that Price and Quantity

Demanded move in opposite directions• When P ↑↓ Q ↓↑

– This is the Law of Demand

• But what happens to Expenditure – the

total amount paid?

– Expenditure = P x Q

– P and Q move in opposite directions



A NUMERICAL EXAMPLE

• Suppose Price decreases from 5 to 4 and

Quantity increases from 6 to 7

– Expenditure1 = P1 x Q1 = 5 x 6 = 30

– Expenditure2 = P2 x Q2 = 4 x 7 = 28

• Expenditure has decreased



A NUMERICAL EXAMPLE

• Suppose Price decreases from 5 to 4 and

Quantity increases from 6 to 8

• E1 = P1 x Q1 = 5 x 6 = 30

• E2 = P2 x Q2 = 4 x 8 = 32

• Expenditure has increased



EXAMPLES (cont.)

• What is the difference between the two

examples?

– In the first example Quantity increased by one

unit when price fell by one

– In the second example Quantity increased by

two units

• In the second example the Demand wasmore Elastic



EXAMPLES (cont.)

%∆P %∆Q η

Example 1 1/4.5 = .22 1/6.5 = .15 .692

Example 2 1/4.5 = .22 1/7 = .29 1.286

Let’s calculate the Elasticity in each example

using the formula for arc elasticity



EXAMPLES (cont.)

%∆P %∆Q η

Example 1 1/4.5 = .22 1/6.5 = .15 .692

Example 2 1/4.5 = .22 1/7 = .29 1.286

Example 1: Inelastic Demand

Example 2: Elastic Demand



THE RELATIONSHIP BETWEEN

EXPENDITURE AND ELASTICITY

Prices Decrease• If %∆Q > %∆P

– Expenditures go up

– η>1 Elastic

• If %∆Q < %∆P – Expenditures go down

– η<1 Inelastic

• If %∆Q = %∆P – Expenditures stay the same – η =1 Unitary Elastic



THE RELATIONSHIP BETWEEN

EXPENDITURE AND ELASTICITY

Prices Increase• If %∆Q > %∆P

– Expenditures go down

– η>1 Elastic

• If %∆Q < %∆P – Expenditures go up

– η<1 Inelastic

• If %∆Q = %∆P – Expenditures stay the same – η =1 Unitary Elastic



TEST YOUR UNDERSTANDING

• You are considering a price increase.

What kind of Demand do you hope your

customers have?

• Elastic?

• Inelastic?

• Unitary Elastic?






customers have?

Inelastic (Customers less sensitive to price)

– Sales revenues (Expenditures) will increase

– We will sell less, so costs will go down

– Profits will increase!




• You are considering a price decrease.


customers have?

• Elastic?

• Inelastic?

• Unitary Elastic?






customers have?

Elastic (Customers more sensitive to price)

– Sales revenues (Expenditures) will increase

– We will sell more, so costs will go up

– Profits might increase (if revenues go up more

than costs)



ELASTICITY OF A STRAIGHT

LINE DEMAND CURVE

• I often draw Demand Curves as straight

lines. (They are easiest to draw.)

• When the demand curve has this shape

the elasticity is changes along the curve

– Elasticity is highest at higher prices

– Elasticity is lowest at lower prices



STRAIGHT LINE DEMAND

• As Price falls,

expenditure goes up

and then goes down

• Where expenditure isincreasing Demand is

Elastic

• Where expenditure is

decreasing Demand

is Inelastic

P Q EXPENDITURE9 1 9

8 2 18

7 3 216 4 24

5 5 25

4 6 243 7 21

2 8 16

1 9 9



STRAIGHT LINE DEMAND

P

9

5

1

1 5 9 Q

D

Elastic

Region

Inelastic

Region

Unitary

Elastic



SOME OTHER DEMAND CURVES

• PERFECTLY

INELASTIC

• PERFECTLY

ELASTIC

D

η=0

P

Q

P

Q

D

η = ∞



UNITARY ELASTIC

0

2

4

6

8

10

12

0 5 10 15 20 25

Quantity

P r i c e

C O S C



FACTORS THAT IMPACT

DEMAND ELASTICITY

FACTORS THAT IMPACT



FACTORS THAT IMPACT

DEMAND ELASTICITY

• “Necessity” vs. “Luxury” (?)

FACTORS THAT IMPACT



FACTORS THAT IMPACT

DEMAND ELASTICITY

• Necessity vs. Luxury (?)

• Close substitutes



Elasticities and Substitutes

• When close substitutes are easily available the

demand for a product will be more elastic.

• What is happening to elasticity of demand as we

go down this list? – Coke from Pizza Hut

– Coke in Gulberg

– Fizzy Drinks in Lahore

– Sweet Drinks in Lahore

– Drinks in Lahore

FACTORS THAT IMPACT



FACTORS THAT IMPACT

DEMAND ELASTICITY

• Necessity vs. Luxury (?)

• Close substitutes

• Time



Elasticity and Time

• When the time period is longer the

elasticity of demand increases

• Longer to adjust to a price change

• A wider range of substitutes are possible



ELASTICITY AND TIME

• Petrol per day • The price of petrolwent up today.

• I’ve already made myplans andcommitments

• Maybe I can driveslower

• There is not muchelse I can do to useless petrol

P

Litres/Day

Dday

P1

P2



ELASTICITY AND TIME

• Petrol per month • The price of petrol

has been up for a

month.

• I have eliminatedmost of my

discretionary travel

• But I still have to get

to work and to school.

P

Litres/Day

Dday

P1

P2

Dmonth



ELASTICITY AND TIME

• Petrol per year • The price of petrol

has been up for a

year.

• I purchased a newfuel efficient car

• I’ve gave up some

other things to buy it

but I sure use a lotless petrol now

P

Litres/Day

Dday

P1

P2

Dmonth

Dyear



ELASTICITY AND TIME

• Petrol per decade • The price of petrolhas been up for 10years.

• I moved closer to my job. I can walk or ridemy bike.

• There is an expressbus to my old school

• I sold my car. Don’tneed it any more.

P

Litres/Day

Dday

P1

P2

Dmonth

Dyear

Ddecade

#8 ELASTICITY OF DEMAND.ppt

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