Elasticity of demand in ECONOMICS ......

Elasticity of demand measures how sensitive the quantity demanded of a good or service is to changes in its price. If demand is elastic, a small price change leads to a significant change in quantity demanded; conversely, if demand is inelastic, quantity demanded changes little with price fluctuations. Factors influencing elasticity include the availability of substitutes, the proportion of income spent on the good, and whether the good is a necessity or luxury. Understanding elasticity helps businesses and policymakers make informed decisions regarding pricing, production, and economic policies.

1. Price Elasticity of Demand

2. Elasticity – the concept
The responsiveness of one variable to changes in another
When price rises, what happens
to demand?
Demand falls
BUT!
How much does demand fall?

3. Elasticity – the concept
If price rises by 10% - what happens to demand?
We know demand will fall
By more than 10%?
By less than 10%?
Elasticity measures the extent to which demand will
change

4. Elasticity
4 basic types used:
Price elasticity of demand
Price elasticity of supply
Income elasticity of demand
Cross elasticity

5. Elasticity
Price Elasticity of Demand
The responsiveness of demand
to changes in price
Where % change in demand
is greater than % change in price – elastic
Where % change in demand is less than % change in price -
inelastic

6. Elasticity
Price ($)
Quantity Demanded
The demand curve can be a
range of shapes each of which
is associated with a different
relationship between price and
the quantity demanded.

7. Elasticity
The Formula:
Ped =
% Change in Quantity Demanded
___________________________
% Change in Price
If answer is between 0 and -1: the relationship is inelastic
If the answer is between -1 and infinity: the relationship is elastic
Note: PED has – sign in front of it; because as price rises
demand falls and vice-versa (inverse relationship between
price and demand)

8. Elasticity
Price
Quantity Demanded (000s)
D
The importance of elasticity
is the information it
provides on the effect on
total revenue of changes in
price.
$5
100
Total revenue is price x
quantity sold. In this
example, TR = £5 x 100,000
= £500,000.
This value is represented by
the grey shaded rectangle.
Total Revenue

9. Elasticity
Price
Quantity Demanded (000s)
D
If the firm decides to
decrease price to (say) £3,
the degree of price elasticity
of the demand curve would
determine the extent of the
increase in demand and the
change therefore in total
revenue.$5
100
$3
140
Total Revenue

10. Elasticity
Price ($)
Quantity Demanded
10
D
5
5
6
% Δ Price = -50%
% Δ Quantity Demanded = +20%
Ped = -0.4 (Inelastic)
Total Revenue would fall
Producer decides to lower price to attract sales
Not a good move!

11. Elasticity
Price ($)
Quantity Demanded
D
10
5 20
Producer decides to reduce price to increase sales
7
% Δ in Price = - 30%
% Δ in Demand = + 300%
Ped = - 10 (Elastic)
Total Revenue rises
Good Move!

12. The Meaning of Price Elasticity of
demand
Elastic Demand: A strong response to a change in price
Unit Elastic demand: A proportional response to a price
change (total amount spent by consumers remains
unchanged)
Inelastic demand : A weak response to a price change

13. Elasticity
If demand is price
elastic:
Increasing price would
reduce TR (% Qd > %
Δ
P)
Δ
Reducing price would
increase TR
(% Qd > % P)
Δ Δ
If demand is price
inelastic:
Increasing price would
increase TR
(% Qd < % P)
Δ Δ
Reducing price would
reduce TR (% Qd < %
Δ
P)
Δ

14. Total Outlay Method
Total Outlay is a way to
calculate the price elasticity
of demand method by
looking at the effect of
changes in price on the
revenue earned by the
producer.
If price and revenue move
in the same direction,
demand is inelastic.
If price and revenue move
in the opposite direction,
demand is elastic
If revenue remains
unchanged in response to
a price change, demand is
unit elastic

15. Elasticity and Total Outlays

16. Total Outlay Method and slope of a
demand curve
Look at Pg 85
Perfectly elastic Demand is where consumers are willing to pay
any price in order to obtain a given quantity of a good or
service. The situation can be represented by a horizontal
demand curve.
An apple grower sells apples, along with many other apple
growers , at a fruit and vegetable market. The grower can
sell the entire load at the going market price. If the grower
tries to sell the apples at a price above the going rate he will
sell none.

17. Perfectly Inelastic demand is where consumers are willing to
pay any price in order to obtain a give quantity of a good or
service. This situation can be represented by a vertical
demand curve. Example a person with a life threatening
illness would be willing to pay almost anything.

19. Review Question
1 and 2 pg 86

20. Factors affecting elasticity of demand
Whether the good is a luxury or a necessity.
-necessities have relative inelastic demand-even if there is an
increase in price, the quantity demanded will not fall to a
great extent
-price elasticity of demand is higher for products that are
regarded as luxuries

21. Factors affecting elasticity of demand
Whether the good has any close substitutes.
Goods with close substitutes tend to have highly elastic
demand.
If the price increases the demand is is likely to contract more
then proportionately.
Goods and Services with few or no close substitutes , such as
water supply, would have inelastic demand- even if price
increase, people cannot switch to another product

22. Factors affecting elasticity of demand
The expenditure on the product as a proportion of income
Items which take up a very small proportion of a person’s
income would have a lower price elasticity of demand,
whereas the demand for more expensive items would tend
to be more elastic.

23. Factors affecting elasticity of demand
The length of time subsequent to a price change
If the price falls may take time to become aware and adjust to
the price change
If it increases, consumers may take time to seek out alternatives
and substitute products

24. Factors affecting elasticity of demand
Whether a good is habit forming (addictive) or not
Relative inelastic demand.
E.G Price rise in Alcho-pops and cigarettes did not lead to a
large decrease in demand.
REVIEW QUESTION 1-3 pg 87
Chapter Review pg 89