S4CH10 v.22-23
S4CH10 v.22-23
S4CH10 v.22-23
Chapter 10
Price elasticity of Demand and Supply
Study Case 1 and Case 2 before we go into the concept of price elasticity of demand.
Case 1
Originally, it costs $65 for double scoop cone.
After the promotion, people can buy two double scoop at $65, i.e., price per cone
decreases. By the law of demand, the quantity demanded for a double scoop cone
increases.
Do you think Haagen-Dazs would necessarily receive a lower total revenue? Why?
the decrease in price may lead to a(n) decrease in total revenue; but
the increase in quantity demanded may lead to a(n) increase in total revenue
the total revenue may increase if the gain in total revenue is larger than the
loss in total revenue
the final change in total revenue depends on price elasticity of demand
Case 2
As the effect of changing the price on total revenue is uncertain, study the following and suggest under what
condition an increase in price leads to a higher total revenue.
The elasticity of demand for electricity from HK Electric and that for bubble tea from Gong Cha is different.
Price elasticity of demand measures how responsive the quantity demanded of a good is to a change
in its price.
In laymen terms, it means the responsiveness of consumers to a change in price of a good.
we measure the responsiveness of consumer by comparing the percentage change in quantity
demanded and the percentage change in price.
e.g., When the price of a good increases,
if the percentage decrease in quantity demanded is larger than the percentage increase in price, the
consumers are said to be (responsive / not responsive) to the increase in price.
Refer to Case 2,
HK Electric Gong Cha
customers are … to price change. relatively not responsive relatively more responsive
When price of a good increases, the quantity demanded decreases. Ed is therefore always negative.
For simplicity, we usually consider the absolute value of the coefficient and ignore the negative sign.
𝑄𝑑1 − 𝑄𝑑0
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 (𝑄𝑑0 + 𝑄𝑑1)/2 𝑥100%
𝐸𝑑 = =
𝑃1 − 𝑃0
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑥 100%
(𝑃0 + 𝑃1)/2
Illustration in a graph
Calculate the price elasticity of demand for each price
range:
a) When price decreases from $9 to $8,
quantity demanded increases from 1 unit to 2 units.
elasticity of demand = 66.67% / -11.76% = -5.67
Illustration:
If the price of a product decreases from $10 to $8, leading to an increase in quantity demanded from 40 to
60 units, then the price elasticity of demand (Ed) can be calculated as:
% change in quantity demanded = [(Qd2 – Qd1) / Qd1] *100% = [(60 – 40) / 40] *100% = 50%
% change in price = [(P2 – P1) / P1] *100% = [(8 – 10) / 10] *100% = -20%
| Ed | = | 50% / -20% | = 2.5
Since we’re concerned with the absolute values in price elasticity, the negative sign is ignored. You can
conclude that the price elasticity of this good, when the price decreases from $10 to $8, is 2.5.
One of the problems with the price elasticity of demand formula is that it gives different values depending
on whether price rises or falls.
If you use different start and end points in our example above - that is, if you assume the price increased
from $8 to $10, and the quantity demanded decreased from 60 to 40, the Ed will be:
% change in quantity demanded = [(40 – 60) / 60] *100% = -33%
% change in price = [(10 – 8) / 8] *100% = 25%
| Ed | = | -33% / 25% | = 1.32, which is different from 2.5
3. Inelastic demand
The percentage change in quantity demanded of the good is smaller than the percentage change in
price.
i.e., consumers are not responsive to price.
Numerical expression: Ed < 1
This would be more similar to the case of (HK Electric / Gong Cha) in
Case 2.
[i.e., the percentage decrease in quantity demanded is smaller than
percentage increase in price]
Numerical expression: Ed = 0
Numerical expression: Ed = 1
P.S. The demand for cigarettes maybe inelastic, but the demand for a particular brand of cigarettes
can be elastic.
Suppose the bus fare increases by 10%, it is likely that many consumers can still afford it as it does not
have a great impact on the total expenditure of consumers. The quantity demanded (would / would not)
decrease much.
In a short period of time, people may find it difficult to find substitutes for a good and tend to stick
with the original good even price increases.
The demand would be more inelastic.
In the long run, people may have more options, for example buying a more fuel-efficient car model,
changing to electric cars etc.
The demand for it tends to be more elastic.
4. Number of uses
If the good has a variety of uses,
When price increases, users from different groups will buy less of it, leading to a larger decrease in
quantity demanded - more elastic.
Steel can be used to produce cars, construction materials, cooking utensils etc.
When the price of steel increases, users from different groups will buy less of it → leading to a relatively
larger decrease in market quantity demanded (when compared to goods with fewer uses).
When the price of a good increases, the quantity demanded for it decreases.
Written explanation: [4 steps!]
If the demand for the good is elastic,
the percentage decrease in quantity demanded is larger than the percentage increase in price.
The loss in total revenue is larger than the gain in total revenue.
The total revenue decreases. must be comparing % changes
instead of absolute changes
Graphical representation:
When the price of a good decreases, the quantity demanded for it increases.
Written explanation: [4 steps!] Graphical representation:
If the demand for the good is elastic,
When the price of a good increases, the quantity demanded for it decreases.
Written explanation: [4 steps!]
If the demand for (the good) is inelastic,
the percentage decrease in quantity demanded is smaller than the percentage increase in price.
The loss in total revenue is smaller than the gain in total revenue.
The total revenue increases.
When the price of a good decreases, the quantity demanded for it increases.
Written explanation: Graphical representation:
If the demand for (the good) is inelastic,
Summary*****
if the demand is elastic if the demand is inelastic
when price increases % ↓ Qd > % ↑ P → TR decreases % ↓ Qd < % ↑ P → TR increases
when price decreases % ↑ Qd > % ↓ P → TR increases % ↑ Qd < % ↓ P → TR decreases
*if the demand is unitarily elastic, % △ Qd = % △ P → TR unchanged
When the direction of the change in P and Q is different, we consider the elasticity of demand to determine the change
in total revenue.
The percentage increase in quantity demanded is larger than the percentage decrease in price.
The gain in total revenue is larger than the loss in total revenue.
Mandy: I like coffee very much! No matter how its price changes, I always buy the same
amount of coffee every week!
Shirley: I like coffee very much too! No matter how its price changes, I always spend the
same amount of money on coffee every week!
Based on their conversation, Mandy's demand for coffee is ____ and Shirley's demand for coffee is
Mary’s elasticity of demand for soft drinks is _______________ while Peter’s elasticity of demand for soft
drinks is __________________ (without regard to the negative sign).
A. between zero and one … equal to zero B. between zero and one … equal to one
C. equal to zero … equal to zero D. equal to zero … equal to one
Suppose the price of petrol has increased. With the aid of a diagram, explain under what condition the bus
companies’ total revenue from provision of bus services will decrease. (8 marks)
Hint / Steps:
1. Any curve shifted? WHY? (1)
2. After the shift in curve, how does the equilibrium price and the equilibrium quantity change? (1)
3. [the condition] if the demand for bus services is (elastic / inelastic), (1)
4. Compare the percentage changes in price and quantity demanded (1)
5. Compare the gain and loss in total revenue (which leads to a decrease in TR)
The price of petrol increases.
As the cost of production of bus services increases, the supply of bus services decreases.
The equilibrium price increases, and the equilibrium quantity decreases.
Under the condition that the demand for bus services is elastic,
The percentage increase in price would be smaller than the percentage decrease in quantity demanded,
The gain in total revenue will be smaller than the loss in total revenue.
When price of a good increases, the quantity supplied increases. Es is therefore always positive.
𝑄𝑠1 − 𝑄𝑠0
𝑥100%
(𝑄𝑠0 + 𝑄𝑠1)/2
=
𝑃1 − 𝑃0
𝑥 100%
(𝑃0 + 𝑃1)/2
Numerical expression: Es = 0
2. Inelastic supply
The percentage change in quantity supplied of the good is
smaller than the percentage change in its price.
i.e., producers are unresponsive to price
/ cannot respond quickly to price
Numerical expression: Es = 1
4. Elastic supply
The percentage change in quantity supplied of the good is larger
than the percentage change in its price.
i.e., producers are responsive to price
/ can respond quickly to price
Numerical expression: Es = ∞
in use idle
e.g., supply of medical services provided by hospitals are relatively inelastic because the availability of
doctors and nurses are limited.
If the industry has a lot of entry barriers (such as huge capital requirement / license required),
fewer producers can enter the industry when the price of those good increases.
- the market supply tends to be more inelastic.
e.g., the supply of taxi licences is fixed by the government - perfectly inelastic
Point to note
We do not discuss total revenue here because the change in total revenue is certain when there is a price
change along a supply curve.
(i.e., when price increases, the quantity supplied increases, the total revenue must increase.)
Suppose the price and the quantity of mosquito repellents sold in Hong Kong changed by 5% and 120%
respectively shortly after the release of the above news. This indicates that during that period and within the
price range, there was an _____ the mosquito repellents in Hong Kong.
A. elastic supply of
B. inelastic supply of
C. elastic demand for
D. inelastic demand for
MC skill -
When one curve shifts, the price change would be along the other curve.
i.e., when demand increases, price increases and quantity increases along the supply curve.
The percentage changes in price and quantity reflects the elasticity of the supply curve.
The curve that shifted would not be the answer.
Price Elasticity of Demand & Supply Page 15
Past Paper Question Types – with explanation
2012 DSE pp Q9
Suppose there is political unrest in the countries exporting crude oil. As a result, there is a 30% increase in the
price of gasoline and a 15% change in the quantity transacted of gasoline. We can conclude that
Explanation
Supply of gasoline decreases. price increases and quantity decreases.
It is along the demand curve – reflecting the elasticity of demand.
When supply shifts, the % changes would reflect the elasticity of demand.
Suppose the price and the quantity of mosquito repellents sold in Hong Kong changed by 5% and 120%
respectively shortly after the release of the above news. This indicates that during that period and within the
price range, there was an _____ the mosquito repellents in Hong Kong.
A. elastic supply of
B. inelastic supply of
C. elastic demand for
D. inelastic demand for
Explanation
Demand for the mosquito repellents increases because of Dengue fever scare.
price increases and quantity increases.
It is along the supply curve – reflecting the elasticity of supply.
When demand shifts, the % changes would reflect the elasticity of supply.