,Principles of Economics,Session 2,Topics To Be Covered,Price Elasticity of Demand Income Elasticity of Demand Cross-Price Elasticity of Demand Elasticity of Supply Application of Elasticity Networks and Positive Feedback,Elasticity,Elasticity is a measure of how much buyers and sellers respond to changes in market conditions It allows us to analyze supply and demand with greater precision.,Price Elasticity of Demand,Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price. It is a measure of how much the quantity demanded of a good responds to a change in the price of that good.,Computing the Price Elasticity of Demand,The price elasticity of demand (Ed) is computed as the percentage change in the quantity demanded divided by the percentage change in price.,Computing the Price Elasticity of Demand,Example: If the price of an ice cream cone increases from $0.50 to $1.00 and the amount customers buy falls from 10 to 8 cones then the elasticity of demand would be calculated as:,Computing the Arc Elasticity of Demand,$3.00,2.50,2.00,1.50,1.00,0.50,2,1,3,4,5,6,7,8,9,10,12,11,P,Qd,0,Ed=0.2,Computing the Arc Elasticity of Demand,Example: If the price of an ice cream cone decreases from $1.00 to $0.50 and the amount customers buy increases from 8 to 10 cones then the elasticity of demand would be calculated as:,Computing the Arc Elasticity of Demand,$3.00,2.50,2.00,1.50,1.00,0.50,2,1,3,4,5,6,7,8,9,10,12,11,P,Qd,0,Ed=0.5,Computing the Arc Elasticity of Demand Using the Midpoint Formula,The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change.,Computing the Arc Elasticity of Demand,Example: If the price of an ice cream cone increases from 0.50 to $1.00 and the amount customers buy falls from 10 to 8 cones the your elasticity of demand, using the midpoint formula, would be calculated as:,Computing the Arc Elasticity of Demand,$3.00,2.50,2.00,1.50,1.00,0.50,2,1,3,4,5,6,7,8,9,10,12,11,P,Qd,0,Ed=0.33,Ranges of Elasticity,Inelastic (E 1) Quantity demanded does not respond strongly to price changes. Elastic (E 1) Quantity demanded responds strongly to changes in price.,Ranges of Elasticity,Unit Elastic (E= 1) Quantity demanded changes by the same percentage as the price. Perfectly Inelastic (E = 0) Quantity demanded does not respond to price changes. Perfectly Elastic (E =) Quantity demanded changes infinitely with any change in price.,Inelastic Demand,Quantity,Price,E 1,Elastic Demand,Quantity,Price,E 1,Unit Elastic Demand,Quantity,Price,E= 1,Perfectly Inelastic Demand,Quantity,Price,2. .leaves the quantity demanded unchanged.,E = 0,Perfectly Elastic Demand,Quantity,Price,E =,Computing the Arc Elasticity of Demand,$3.00,2.50,2.00,1.50,1.00,0.50,2,1,3,4,5,6,7,8,9,10,12,11,P,Qd,0,Ed1,Ed = ,Ed1,Ed = 1,Ed = 0,Linear Demand Curve Qd = a + bP Qd =12 4P,Arc Elasticity vs. Point Elasticity,Arc Elasticity It is calculated over a portion of demand curve. Point Elasticity It is computed at a point on demand curve.,Computing the Point Elasticity of a Linear Demand Curve,$3.00,2.50,2.00,1.50,1.00,0.50,2,1,3,4,5,6,7,8,9,10,12,11,P,Qd,0,Ed = ,Ed=5,Ed = 1,Ed = 0,Ed=2,Ed=0.5,Ed=0.2,Computing the Point Elasticity of a Linear Demand Curve,A,B,D,E,P,Qd,O,C,Elasticity vs. Slope,$3.00,2.50,2.00,1.50,1.00,0.50,2,1,3,4,5,6,7,8,9,10,12,11,P,Qd,0,Computing the Point Elasticity of a Curvilinear Demand,$3.00,2.50,2.00,1.50,1.00,0.50,2,1,3,4,5,6,7,8,9,10,12,11,P,Qd,0,A,Ed=2,B,Ed=1,Elasticity and Total Revenue,Total revenue is the amount paid by buyers and received by sellers of a good. Computed as the price of the good times the quantity sold. TR = P x Q,$4,Demand,Quantity,P,0,Price,P x Q = $400,(total revenue),100,Elasticity and Total Revenue,Elasticity and Total Revenue,$3.00,2.50,2.00,1.50,1.00,0.50,2,1,3,4,5,6,7,8,9,10,12,11,P,Qd,0,TRA=0.510=5,TRB=1.08=8,With inelastic demand (Ed1), an increase in price leads to an increase in total revenue.,TR=P Q,Elasticity and Total Revenue,$3.00,2.50,2.00,1.50,1.00,0.50,2,1,3,4,5,6,7,8,9,10,12,11,P,Qd,0,TRA=24=8,TRB=2.52=5,With elastic demand (Ed1), an increase in price leads to a decrease in total revenue.,TR=P Q,Elasticity and Total Revenue,$3.00,2,1,3,4,5,6,7,8,9,10,12,11,P,Qd,0,TRA=1.257=8.75,TRB=1.755=8.75,With unit-elastic demand (Ed=1), an increase in price leads to no change in total revenue.,TR=P Q,Determinants of Price Elasticity of Demand,Necessities versus Luxuries Availability of Close Substitutes Definition of the Market Time Horizon,Determinants of Price Elasticity of Demand,Demand tends to be more elastic : if the good is a luxury. the longer the time period. the larger the number of close substitutes. the more narrowly defined the market.,Pr