Elasticity of demand

Elasticity of demand What elasticity measures? How the price elasticity formula is applied

to measure the elasticity of demand? The difference between elastic, inelastic

and unitary elastic demand? How total revenue varies in each of these

tree cases? The meaning of perfect elasticity and

perfect inellasticity

Price elasticity of demand

is a measure of the sensitivity of quantity demanded to chages in the price of a product

When quantity demanded is relatively sensitive (insensitive) to a price change demand is said to be elastic (inelastic)

Degree of elasticityThe exact degree of elasticity can be

measured by using a formula to compute the elasticity coefficient:

where:D – percentage change in demand: (yt-yt-1)/yt-1P – percentage change in prices: (xt-xt-1)/xt-1

PDEC

How to estimate price elasticity

P - price D - demand ∆P ∆D Ep

2,5 80

5 60 100% -25% -0,25

7,5 40 50% -33% -0,67

10 20 33% -50% -1,50

It is important to note that the elasticity of demand is not the same at all prices and that demand is typically elastic at higher and inelastic at lower prices

Elastic, inelastic and unit elastic demand

Demand is elastic (inelastic, unit elastic) when the percentage change in quantity is greater then (less then, equal

to) the percentage change in price and the elasticity coefficient is greater than (less

than, equal to) 1

The sign of elasticity coeficientBecause price and quantity demanded are inversely related to each other the price elasticity of demand coefficient is a negative number – but economists ignore the minus sign in front of the coefficient and focus their attention on its absolute value

The price elasticity of demand for a product depends upon the number of good subsitutes the

product has its relative importance in the

consumer’s budget whether it is a necessity or luxury

Relation between price elasticity and revenue

The way in which total revenue changes (increases, decreases, or remains constant) when price changes is a test of the elasticity of demand for a productFor elastic demand Ep(- ∞ ;-1): when price decreases (increases) then revenues increases (decreases)For inelastic demand Ep(- 1 ; 0): when price decreases (increases) then revenues decreases (increases)For unit elastic demand Ep=-1: the revenues are maximum

The example of the previous rule

P – price in £

D-demand in tho.of units

∆P ∆D Ep Revenues in tho. of £

2,50 80 -100% 25% -0,25 200

5,00 60 -10% 7% -0,67 300

5,50 56 -9% 7% -0,79 308

6,00 52 -4% 4% -0,92 312

6,25 50 -12% 12% -1,00 312,5

7,00 44 -7% 9% -1,27 308

7,50 40 -33% 50% -1,50 300

10,00 20

Fill-in questions 1 To find out that the demand is elastic

you must know (price elasticity of demand, income elasticity of demand)……………...

Fill-in questions 2 If a relatively large change in price results

in a relatively small change in demand, demand is (elastic/ineclastic/perfect eleasit)…………………………….

If a relatively small change in price results in a relatively large change in demand, demand is (elastic/ineclastic/perfect eleastic)…………………………..

Fill-in questions 3 If a change in price causes no change in

demand, demand is perfectly (elastic, inelastic)…………………...and the demand curve is (perpendicular to any axis, slopes down in the rights)…………………

If an extremely small change in price results in an extremely large change in demand, demand is (perfectly elastic/perfectly inelastic)

Fill-in questions 4If the price of a commodity declineswhen demand is inelastic the loss of revenue due to the lower price is (greater than, less then, equal to) …………………….the gain in revenue due to the greater quantity demandedwhen demand is elastic the loss of revenue due to the lower price is (greater than, less then, equal to) …………………….the gain in revenue due to the greater quantity demandedwhen demand is inelastic the loss of revenue due to the lower price is (greater than, less then, equal to) …………………….the gain in revenue due to the greater quantity demanded

Fill-in questions 5 If demand is elastic, price and total

revenue are (directly, inversely) …….…… related

If demand is inelastic, price and total revenue are (directly, inversely) …….…… related

Fill-in questions 6Complete the summary table below

If demand is:

The elasticity coefficient is

If price rises, total revenue

will

If price falls, total revenue

will

Elastic

Inelastic

Of unitary elasticity

Fill-in questions 6Which of below determinants are not the determinants of the elasticity of demand:1.The number of good substitute products2.The relative importance of the product in the total budged of the buyer3.Whether the good is a necessity or a luxury

Fill-in questions 7If the demand schedules for a certain product are those given in the table, answer the following questions.

Price in $ Demand in units10 129 138 147 156 165 174 18

• What is price elasticity of demand for price P=6$...........................

• If we reduct price to 5$, revenus will (decrease/increase)………• What is the „best” price for this product……………………………..