Elasticity of Demand Supply
Elasticity of Demand Supply
Elasticity of Demand Supply
SUPPLY
ELASTICITY: MEANING
Price
1. A 25% $5
increase
in price... 4
Demand
50 100 Quantity
2. ...leads to a 50% decrease in quantity.
Inelastic Demand
- Elasticity is less than 1(Percentage change in
demand is less than percentage change in price, 0< ED <
1)
Price
1. A 25% $5
increase
in price... 4
Demand
90 100 Quantity
2. ...leads to a 10% decrease in quantity.
Unit Elastic Demand
- Elasticity equals 1 (Percentage change in demand is
same as percentage change in price, ED = 1)
Price
1. A 25% $5
increase
in price... 4
Demand
75 100 Quantity
2. ...leads to a 25% decrease in quantity.
Perfectly Elastic Demand
- Elasticity equals infinity (ED = ∞)
Price
1. At any price
above $4, quantity
demanded is zero.
$4 Demand
2. At exactly $4,
consumers will
buy any quantity.
Price Demand
1. An $5
increase
in price... 4
100 Quantity
2. ...leaves the quantity demanded unchanged.
MEASURMENT OF PRICE ELASTICITY OF
DEMAND
Graphical method
Q / Q Q P
EP
P / P P Q
ARC PRICE ELASTICITY OF DEMAND
Ratio of the percentage of change in quantity
demanded to the percentage change in price,
measured over a discrete interval of a demand
curve
Q2 Q1 P2 P1
Ep
(Q1 Q2 ) / 2 ( P1 P2 ) / 2
Q2 Q1 P2 P1
EP
P2 P1 Q2 Q1
EXERCISE
Q = 60,00,000 – 10,00,000 P
Q: no of decks of cards demanded
P: price
Elasticity
differs along a
linear demand
curve
RELATIONSHIP BETWEEN PRICE, TOTAL REVENUE
& Ed: TOTAL OUTLAY METHOD
PRICE TOTAL Ed
REVENUE/
OUTLAY
↑ ↑ <1
↑ ↓ 1
↓ ↓ <1
↓ ↑ 1
↑/↓ same =1
Price Elasticity & Total Revenue
Table 6.2
Elastic Unitary elastic Inelastic
%Q%P %Q%P %Q%P
Q-effect No dominant P-effect
dominates effect dominates
Price
TR falls No change in TR TR rises
rises
Price
TR rises No change in TR TR falls
falls
19
EXAMPLE
The manager faces foll dd curve for CDs.
24
18
16
13
11
9
7
= P + QdP = P 1 + dP.Q
dQ dQ P
1
MR P 1
EP
TR 1000
900
800
700
600
500
400
300
200
100
0
100 200 300 400 500 600 700
Q
MR,P 8
Elastic
6
4
Ep = -1
2 Inelastic
0
100 200 300 400 500 600 700 Q
-2
-4
-6
RELATIONSHIP BETWEEN MARGINAL REVENUE,
PRICE & ELASTICITY OF DEMAND
MR TR Ed
MR >0 TR as Q Elastic
Availability of substitutes
Nature of commodity
Point Elasticity
dQ Y
εY = x
dY Q
Arc Elasticity
Q2 Q1 Y2 Y1
EY
(Q1 Q2 ) / 2 (Y1 Y2 ) / 2
EXCERCISE
Forecasting demand
Point Elasticity
dQA PB
εx = x
dPB QA
Arc Elasticity
Q2 A Q1 A P2 B P1B
Ex
(Q1 A Q2 A ) / 2 ( P1B P2 B ) / 2
EXCERCISE
Answer: 2.5
KNOWING FROM THE DEMAND FUNCTION
Example:
d
QX 10 2 PX 3PY 2 M
QX 0 X PX Y PY M M H H
d
PX PY M
EQX , PX X EQX , PY Y EQX , M M
QX QX QX
Own Price Cross Price Income
Elasticity Elasticity Elasticity
EXAMPLE
Given:
Qd = 200 - 2 P + .05 I + .5 W + .5 Pc
P = 95, I = 1000, W = 80, Pc = 200
Qd = 200
Ep = - 2 (95/200) = -.95
Epc = .5(200/200)= .5
PROMOTIONAL (ADVERTISING)
ELASTICITY OF DEMAND
d
% Q X 25.92%
CASE 3: IMPACT OF A CHANGE IN A
COMPETITOR’S PRICE
CONTD…
EXERCISE (2) QUESTIONS
Compute Quantity of X demanded for given values of P,
M, Pr.
Calculate Ed. At this point on dd for X, is dd elastic,
unitary elastic or inelastic? How would increasing the
price of X effect TR? Explain.
Calculate income Ed. Is the good normal or inferior?
Explain how a 4% increase in income would affect dd for
X, cetirus peribus.
Calculate cross Pd. Are the goods X & Y substitutes or
compliments? Explain how a 5% decrease in price of
related good would effect dd for X, cetirus peribus.
ELASTICITY OF SUPPLY
ELASTICITY OF SUPPLY
% ∆ Quantity supplied
ES =
% ∆ Price
ELASTICITY OF SUPPLY
Point elasticity
dQ P1
S
dP Q1
Arc elasticity
Q2 Q1 P2 P1
Es
(Q1 Q2 ) / 2 ( P1 P2 ) / 2
ELASTICITY OF SUPPLY: TYPES
Es = ∞ Perfectly elastic
1 < Es < ∞ Relatively elastic
Es = 1 Unitary elastic
0 < Es < 1 Relatively
inelastic
Es = 0 Perfectly
inelastic
(I) PERFECTLY ELASTIC SUPPLY
Y
When the supply
for a product
PRICE changes –
S increases or
decreases even
when there is no
change in price,
it is known as
O X
PERFECTLY
ELASTIC SUPPLY
QUANTITY SUPLIED
(II) RELATIVELY ELASTIC SUPPLY
Y
When the
S proportionate
PRICE change in
supply is more
than the
proportionate
changes in
price, it is known
O X as relatively
elastic supply.
QUANTITY SUPLIED
(III) UNITARY ELASTIC SUPPLY
Y When the
proportionate
S
change in
PRICE supply is equal
to proportionate
changes in
price, it is
known as
unitary elastic
O X supply
QUANTITY SUPLIED
(IV) RELATIVELY INELASTIC SUPPLY
Y
When the
S proportionate
PRICE change in
supply is less
than the
proportionate
changes in
price, it is
O X
known as
relatively
QUANTITY SUPLIED inelastic supply
(V) PERFECTLY INELASTIC SUPPLY
Y S
When there is
PRICE no change in
the quantity
supplied with
the change in
its price, it is
perfectly
O X inelastic
supply
QUANTITY SUPLIED
ELASTICITY OF SUPPLY: DETERMINANTS
Time
Flexibility of inputs
Mobility of inputs
Answer: 2