Elasticity of demand
1
Elasticity of demand
2
 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
3
 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 elasticity
4
The exact degree of elasticity can be measured
by using a formula to compute the
elasticity coefficient:
D
EC 
P
where:
 D – percentage change in demand: (yt-yt-1)/yt-1
 P – percentage change in prices: (xt-xt-1)/xt-1
How to estimate price elasticity
5
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
6
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
Types of price elasticity
of demand
7
Elasticity
Description
Behavior
Ep = 0
Perfectly inelastic demand
changes in the price do not affect the quantity
demanded for the good
- 1 < Ep < 0
Inelastic or relatively inelastic demand
percentage change in quantity demanded is
smaller than that in price
Ep = - 1
Unit elastic, unit elasticity, unitary elasticity, or
unitarily elastic demand
percentage change in quantity is equal to that in
price
- ∞ < Ep < - 1
Elastic or relatively elastic demand
percentage change in quantity demanded is
greater than that in price
Ep = - ∞
Perfectly elastic demand
any increase in the price, no matter how small,
will cause demand for the good to drop to zero
Necessity good
8
Is type of normal good. Like any other normal good, when income rises, demand increases.
But the increase for a necessity good is less than proportional to the rise in income, so the
proportion of expenditure on these goods falls as income rises (this observation for food is
known as Engel's law)
Necessity goods are goods that we can't live without and won't likely cut back on even when
times are tough, for example food, power, water and gas (most necessity goods are usually
produced by a public utility)
The income elasticity of a necessity good is thus between zero and one. The more necessary a
good is, the lower the price elasticity of demand, as people will attempt to buy it no matter
the price.
The sign of elasticity coeficient
9
Because 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
10
 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
11
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 product
 For 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
Perfectly inelastic demand: Ec=0
12
 changes in the price do
not affect the quantity
demanded for the
good;
 raising prices will cause
total revenue to
increase
(relatively) inelastic demand:-1<Ec<0
13
 percentage change in
quantity demanded is
smaller than that in
price
 when the price is
raised, the total
revenue rises, and vice
Unit (unitary) elastic demand: Ec=-1
14
 percentage change in
quantity is equal to that
in price,
 a change in price will
not affect total revenue
(relatively) elastic demand: -∞<Ec<-1
15
 percentage change in
quantity demanded is
greater than that in
price
 when the price is
raised, the total
revenue falls, and vice
versa
Perfectly elastic demand: Ec= -∞
16
 any increase in the
price, no matter how
small, will cause
demand for the good to
drop to zero
 when the price is
raised, the total
revenue falls to zero
The example of the previous rule
17
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
18
 To find out that the demand is elastic you must know
(price elasticity of demand, income elasticity of
demand)……………...
Fill-in questions 2
19
 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
20
 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 4
21
If the price of a commodity declines
 when 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
 when 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 demanded
 when 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
22
 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 6
23
Complete the summary table below
The elasticity
coefficient is
If demand
is:
Elastic
Inelastic
Of unitary
elasticity
If price rises,
total revenue will
If price falls,
total revenue
will
Fill-in questions 6
24
Which of below determinants are not the
determinants of the elasticity of demand:
1. The number of good substitute products
2. The relative importance of the product in the total
budged of the buyer
3. Whether the good is a necessity or a luxury
Fill-in questions 7
25
If the demand schedules for a certain product are those
given in the table, answer the following questions.
Price in $
Demand in units
10
12
9
13
8
14
7
15
6
16
5
17
4
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……………………………..