ECON107
Principles of
Microeconomics
Week 8
NOVEMBER 2013
Chapter-4
1
8w/11/2013
Dr. Mazharul Islam
4
8w/11/2013
Elasticity
Dr. Mazharul Islam
3
Lesson Objectives
 Explain
the factors that influence
the elasticity of demand.
 Explain the factors that influence
the elasticity of supply.
 Explain the relationship between
revenue and elasticity
8w/11/2013
Dr. Mazharul Islam
4
The Factors that Influence the
Elasticity of Demand
The availability and closeness of
substitutes goods.
The proportion of income spent
on the good.
The time elapsed since a price
change.
8w/11/2013
Dr. Mazharul Islam
5
The Factors that Influence the
Elasticity of Demand
The availability and closeness of
substitutes.
The greater and closer the substitutes for a
good or service, the more elastic is the
demand for the good or service. Because
consumers could choose its substitutes easily.
The
demand for a good is elastic if a substitute for
it is easy to find.
The demand for a good is inelastic if a substitute
for it is hard to find.
8w/11/2013
Dr. Mazharul Islam
6
The Factors that Influence the
Elasticity of Demand
The availability and closeness of
substitutes.
Necessities,
such as food or housing,
generally have inelastic demand.
Luxuries, such as exotic vacations,
generally have elastic demand.
8w/11/2013
Dr. Mazharul Islam
7
The Factors that Influence the
Elasticity of Demand
The proportion of income spent
on the good
The greater the proportion of income consumers
spend on a good, the larger is the elasticity of
demand for that good. Because a change in the
price of such a good has an affect consumers'
budget with a bigger magnitude. Consumers will
respond by cutting back more on these product
when price increases.
8w/11/2013
Dr. Mazharul Islam
8
The Factors that Influence the
Elasticity of Demand
Time Elapsed Since Price
Change
The longer the time after the price change,
the more elastic will be the demand. It is
because consumers are given more time to
carry out their actions. The longer the
adjustment period, increase the consumers’
ability to substitute away from relatively
higher-priced products toward lower-priced
substitutes.
8w/11/2013
Dr. Mazharul Islam
9
Initial price = $1.00
Dw = the demand curve one week
after the price change
Dm = one month after
Dy, = one year after.
Suppose the price now
increases to $1.25. The
more time for consumers to
respond to price increase,
the greater the reduction in
quantity demanded.
$1.25
$1.00
Dw shows that one week after
the price increase, the quantity
demanded has not changed
much – in this case from 100
to 95. Conversely, after one
month, the quantity demanded
has declined to 75, and after
one year to 50 per day.
8w/11/2013
Dy
Dw
0
50
75 95 100
Dm
Quantity per
period
Note that among these demand curves, the
flatter the demand curve, the more price
elastic the demand.
Dr. Mazharul Islam
10
More Elasticities of Demand
 Cross
elasticity of demand
The responsiveness of the demand for one
good to changes in the price of another
good is called the cross-price elasticity of
demand
In simplest terms the percent change in the
demand of one good divided by the
percent change in the price of another
good.
8w/11/2013
Dr. Mazharul Islam
11
More Elasticities of Demand
 Cross
elasticity of demand
The responsiveness of the demand for one
good to changes in the price of another good
is called the cross-price elasticity of demand.
In simplest terms the percent change in the
demand of one good divided by the percent
change in the price of another good.
The formula for calculating the cross elasticity
Percentage change in quantity demanded
= -----------------------------------------------------------------------Percentage change in price of substitute or
complement or unrelated
8w/11/2013
Dr. Mazharul Islam
12
More Elasticities of Demand
Cross
elasticity of demand
Its numerical value can be positive, negative,
or zero depending on the nature of goods.
 If goods are substitutes, the cross elasticity of
demand is positive
 If goods are complements, the cross
elasticity of demand is negative
 If goods are unrelated, the cross elasticity of
demand is zero.
8w/11/2013
Dr. Mazharul Islam
13
More Elasticities of Demand
 Income
elasticity of demand
The income elasticity of demand measures
how responsive demand is to a change in
income.
In simplest terms the percent change in the
demand of one good divided by the percent
change in income.
The formula for calculating the income elasticity of
demand
Percentage change in quantity demanded
= --------------------------------------------------------------------------Percentage change in income
8w/11/2013
Dr. Mazharul Islam
14
More Elasticities of Demand
 Income
elasticity of demand
 If
the income elasticity of demand is greater
than 1, demand is income elastic and the
good is a normal good (luxury goods)
 If the income elasticity of demand is greater
than zero but less than 1, demand is income
inelastic and the good is a normal good
(necessity goods)
 If the income elasticity of demand is less than
zero (negative) the good is an inferior good.
8w/11/2013
Dr. Mazharul Islam
15
Elasticity of Supply
 The
elasticity of supply measures the
responsiveness of the quantity supplied to a
change in the price of a good when all
other influences on selling plans remain the
same.
 In simplest term, The price elasticity of
supply equals the percent change in
quantity supplied divided by the percent
change in price.
The elasticity of supply =
Percentage change in quantity supplied
-----------------------------------------------------------Percentage change in price
8w/11/2013
Dr. Mazharul Islam
16
Elasticity of Supply
Note that the categories of supply
elasticity same as demand elasticity.
If
supply elasticity is less than 1.0, supply is
inelastic
If it equals 1.0, supply is unit elastic
If it exceeds 1.0, supply is elastic
If it is infinity, supply is perfectly elastic
If it is zero, supply is perfectly inelastic.
8w/11/2013
Dr. Mazharul Islam
17
Elasticity of Supply
 Calculation
formula is
Qs
Qs  Qs
%Qs
Qave
(Qs  Qs ) / 2



S %P
P
P  P

(
P

P
)/2
Pave
E
Here, P = initial price, Qs = initial quantity, P’ =
new price, Q’s = new quantity,  = change
 Due
to law of supply, the price elasticity
of supply is usually a positive number.
8w/11/2013
Dr. Mazharul Islam
18
The Factors that Influence the
Elasticity of Supply
The elasticity of supply depends on
 Resource availability and
substitution
possibilities.
 Time frame for supply decision.
Number of Producers
Easy of storing stock
Improvement in Technology
Stock of finished goods
Increase
in cost of production
compared to output.
8w/11/2013
Dr. Mazharul Islam
as
19
The Factors that Influence the
Elasticity of Supply
Resource availability and substitution
possibilities
The
easier it is to substitute among the
resources used to produce a good or service,
the greater is its elasticity of supply.
Alternatively also true.
So the greater the availability of resources,
the supply of goods and services will be
elastic and the smaller the availability, the
supply will be inelastic.
8w/11/2013
Dr. Mazharul Islam
20
Time frame for supply decision
Supply becomes more elastic over time
producers adjust to price changes
Sw
Sm
Sy
Price per unit
Sw is the supply curve when the
period of adjustment is a week. In
this situation, the higher price does
not elicit much of a response in
quantity supplied because firms
have little time to adjust  supply
curve is inelastic if the price
increases from $1.00 to $1.25
as
Sm is the supply curve when the
adjustment period is one month.
Here the firms have a greater
0
ability to vary output  supply is
100
140 200 Quantity per period
110
more elastic
Supply is even more elastic when the adjustment period is a year as
shown by Sy
8w/11/2013
Dr. Mazharul Islam
21
The Factors that Influence the
Elasticity of Supply
 Number
of producers
More producers mean that the output can be
increased more easily. Thus supply is more
elastic.
 Easy
of storing stocks
If goods can be stocked with ease and have a
long shelf life, the supply will be elastic,
otherwise inelastic. For example perishable
goods such as fresh flowers, vegetables have
comparatively inelastic supply because it is
difficult to store them for longer periods.
8w/11/2013
Dr. Mazharul Islam
22
The Factors that Influence the
Elasticity of Supply
 Improvement
in Technology
In industries where there is a rapid improvement
in technology, the price elasticity of supply of
such goods will be more elastic as compared
to industries where there is not much
improvement in technology.
 Stock
of finished goods
In
industries
where
there
are
high
inventories/stocks of finished goods, the
suppliers can easily supply more as the price
rises. Thus, the price elasticity of supply for
these goods will be elastic.
8w/11/2013
Dr. Mazharul Islam
23
The Factors that Influence the
Elasticity of Supply
Increase
in cost of production as
compared to output
In cases where there is a significant increase
in cost of production when output is
increased, supply is inelastic. This is
because suppliers will have to have to do
a significant investment in order to
increase the output. It will take time and
some suppliers may be hesitant in doing
so.
8w/11/2013
Dr. Mazharul Islam
24
Elasticity and Total Revenue
Total
revenue (TR) is the total amount
of money that received by selling
goods or services. That means TR
equals the price of the good multiplied
by the quantity sold  TR = p x q
What happens to total revenue when
price changes?
8w/10/2013
Dr. Mazharul Islam
25
Elasticity and Total Revenue
If demand is elastic:
A given percentage rise in price brings a larger
percentage decrease in the quantity
demanded. Total revenue decreases.
If demand is inelastic:
A given percentage rise in price brings a smaller
percentage decrease in the quantity
demanded. Total revenue increases.
If demand is unit elastic: No change in total
revenue
8w/10/2013
Dr. Mazharul Islam
26
Elasticity and Total Revenue
Total revenue test:
 If price and total revenue change in
the opposite directions, demand is
elastic.
 If a price change leaves total revenue
unchanged, demand is unit elastic.
 If price and total revenue change in
the same direction, demand is
inelastic.
8w/10/2013
Dr. Mazharul Islam
Price per unit
27
(a) Demand and Price Elasticity
$100
90
80
70
60
50
40
30
20
10
a
b
c
d
e
0
100 200
500
D
800 900 1,000
Quality per period
(b) Total Revenue
TR = p x q
Total revenue
$25,000
Total
revenue
0
8w/10/2013
Quantity per period
500
Dr. Mazharul Islam
1,000
28
Now it’s over for today. Do you
have any question?
5w/9/2013
Dr. Mazharul Islam