Law of demand and demand elasticity
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Transcript of Law of demand and demand elasticity
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Law of DemandOther things equal, the quantity demanded of
a good falls when the price of good rises .Elasticity
A measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants.
Price Elasticity of DemandA measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price.
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QuestionSuppose that your demand schedule for compact discs is as follows:
PriceQUANTITY
DEMANDEDQUANTITY
DEMANDED
$ (INCOME = $10,000) (INCOME = $12,000)
8 40 50
10 32 45
12 24 30
14 16 20
16 8 12
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a. Use the midpoint method to calculate your price elasticity of demand as the price of compact discs increases from $8 to $10 if (i) your income
is $10000 and (ii) your income is $ 12000.
b. Calculate your income elasticity of demand as your income increases from $10,000 to $12000 if (i) the price is $12 (ii) the price is $16.
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Solutiona(i). The price of compact discs increase
from $8 to $10, (i) if our income is $10,000;
According to the midpoint method, (Q2 - Q1)/[( Q2 + Q1)/2]
Price elasticity of demand = (P2 - P1)/[( P2 + P1)/2]
P1 = 8 Q1 = 40P2 = 10 Q2 = 32
PriceQUANTITY
DEMANDED
QUANTITY DEMANDE
D
$(INCOME = $10,000)
(INCOME = $12,000)
8 40 50
10 32 45
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So, (32 -40)/ [ (32+ 40/2]
Price elasticity of demand = (10 - 8)/[( 10 + 8)/2]
-8/ 72/2 -8/36 -2/9
Price elasticity of demand = = = 2/18/2 2/9
2/9
Price elasticity of demand = -1
Our price elasticity of demand is equal 1So, our price elasticity of demand is unit elastic
demand.
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Price
Quantity
q2
q1
p2
p1
P1 = 8 , Q1 = 40 – total revenue = p1 x Q1 = 8x40 = 320P2= 10,Q2 = 32 – total revenue = P2 x Q2 = 10x32 = 320
-in unit elastic demand(Ed=1) , a change in the price does not affect total revenue.
Demand curve
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a(ii). The price of compact discs increase from $8 to $10, (ii) if our income is $12,000;
According to the midpoint method, (Q2 - Q1)/[( Q2 + Q1)/2]
Price elasticity of demand = (P2 - P1)/[( P2 + P1)/2]
P1 = 8 Q1 = 50P2 = 10 Q2 = 45
PriceQUANTITY DEMANDE
D
QUANTITY DEMANDE
D
$(INCOME = $10,000)
(INCOME = $12,000)
8 40 50
10 32 45
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So, (45 -50)/ ( 45+ 50/2]
Price elasticity of demand = (10 - 8)/[( 10 + 8)/2]
-5/ 95/2 -5x 2/95 -2/19 2 9
Price elasticity of demand = = = = x 2/18/2 2/9 2/9 19 2
Price elasticity of demand = 9/19 = 0.47
Our price elasticity of demand is smaller than 1So, Our price elasticity of demand is inelastic
demand.
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Price
Quantity
q2
q1
p2
p1
P1 = 8 , Q1 = 50 – total revenue = p1 x Q1 = 8x50 = 400P2= 10,Q2 = 45 – total revenue = P2 x Q2 = 10x32 = 450
-in inelastic demand (Ed < 1) , a price increase rises total revenue and a price decrease reduces total revenue.
Demand curve
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b. Calculate your income elasticity of demand as your income increases from $10,000 to $12000 if (i) the price is $12 (ii) the price is $16.
i. Our income elasticity of demand is as our income increases from $ 10,000 to $ 12000 if (i) the price is $ 12
According to the equation Percentage change in
quantity demandedIncome elasticity of demanded =
Percentage change in incomePrice
QUANTITY DEMANDED
QUANTITY DEMANDED
$ (INCOME = $10,000) (INCOME = $12,000)
12 24 30
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Point A: Income = 10,000 Quantity Demanded = 24 Point B: Income = 12,000 Quantity Demanded = 30
Going to Point A to Point B, the income rises by 20 percent because 12000-10000/10000 x 100 = 20
andthe quantity demanded also rise 25 percent because 30-24/24 x 100 = 25
25 5Income elasticity of demanded = = = 1.25
20 4
As our income increases from $ 10,000 to $ 12000 if (i) the price is $ 12 , our income elasticity of demand is 1.25 and so it is positive income elasticity and we conclude that is normal good.
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ii. Our income elasticity of demand is as our income increases from $ 10,000 to $ 12000 if (ii) the price is $ 16
According to the equation
Percentage change in quantity demanded
Income elasticity of demanded = Percentage change in
income
PriceQUANTITY
DEMANDEDQUANTITY
DEMANDED
$ (INCOME = $10,000)
(INCOME = $12,000)
16 8 12
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Point A: Income = 10,000 Quantity Demanded = 8 Point B: Income = 12,000 Quantity Demanded = 12
Going to Point A to Point B, the income rises by 20 percent because 12000-10000/10000 x 100 = 20
andthe quantity demanded also rise 50 percent because 12-8/12 x 100 = 33
50 10Income elasticity of demanded = = = 2.5
20 4
As our income increases from $ 10,000 to $ 12000 if (ii) the price is $ 16 , our income elasticity of demand is 2.5 and so it is positive income elasticity and we conclude that is normal good.