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Elasticity and Its Application

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Ita Burhan
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194 views36 pages

Elasticity and Its Application

Uploaded by

Ita Burhan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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PowerPoint Slides

to accompany
Principles of Economics, An Asian Edition (2nd Edition)
N. Gregory Mankiw | Euston Quah | Peter Wilson
5

ELASTICITY AND ITS APPLICATION

© 2013 Cengage Learning


 … allows us to analyze supply and
demand with greater precision.

 … is a measure of how much buyers


and sellers respond to changes in
market conditions
 The price elasticity of demand is a measure of
how much the quantity demanded of a good
responds to a change in the price of that good.
 Computed as the percentage change in quantity
demanded divided by the percentage change in price
 When we talk about elasticity, that
responsiveness is always measured in
percentage terms.
 Availability of Close Substitutes
 Necessities versus Luxuries
 Definition of the Market
 Time Horizon
 The price elasticity of demand is
computed as the percentage change in
the quantity demanded divided by the
percentage change in price.
P e rc e n ta g e c h a n g e in q u a n tity d e m a n d e d
P ric e e la s tic ity o f d e m a n d =
P e rc e n ta g e c h a n g e in p ric e
 Example: If the price of an ice cream cone
increases from $2.00 to $2.20 and the
amount you buy falls from 10 to 8 cones,
then your elasticity of demand would be
calculated as: P e rc e n ta g e c h a n g e in q u a n tity d e m a n d e d
P ric e e la s tic ity o f d e m a n d =
P e rc e n ta g e c h a n g e in p ric e

(1 0  8 )
100 20%
10   2
( 2 .2 0  2 .0 0 )
100 10%
2 .0 0
 The midpoint formula is preferable
when calculating the price elasticity of
demand because it gives the same
answer regardless of the direction of
the price change. (Q  Q ) /[(Q  Q ) / 2]
Price elasticity of demand = 2 1 2 1
( P2  P1 ) /[( P2  P1 ) / 2]
 Example: If the price of an ice cream
cone increases from $2.00 to $2.20 and
the amount you buy falls from 10 to 8
cones, then your elasticity of demand,
using the midpoint formula, would be
calculated as: (10  8)
(10  8) / 2 22%
  2.32
(2.20  2.00) 9.5%
(2.00  2.20) / 2
 Inelastic Demand
 Quantity demanded does not respond
strongly to price changes.
 Price elasticity of demand is less than one.
 Elastic Demand
 Quantity demanded responds strongly to
changes in price.
 Price elasticity of demand is greater than
one.
(100  50)
(100  50)/2
ED 
(4.00  5.00)
Price (4.00  5.00)/2
$5
67 percent
4   3
Demand  22 percent

0 50 100 Quantity
Demand is price
elastic.
 Perfectly Inelastic
 Quantity demanded does not respond to
price changes.
 Perfectly Elastic
 Quantity demanded changes infinitely with
any change in price.
 Unit Elastic
 Quantity demanded changes by the same
percentage as the price.
 Because the price elasticity of demand
measures how much quantity
demanded responds to the price, it is
closely related to the slope of the
demand curve.
 But it is not the same thing as the
slope!
 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  Q
 With an inelastic demand curve, an
increase in price leads to a decrease in
quantity that is proportionately smaller.
Thus, total revenue increases.
 With an elastic demand curve, an
increase in the price leads to a
decrease in quantity demanded that is
proportionately larger. Thus, total
revenue decreases.
 Income Elasticity of Demand
 Income elasticity of demand measures how
much the quantity demanded of a good
responds to a change in consumers’
income.
 It is computed as the percentage change in
the quantity demanded divided by the
percentage change in income.
 Computing Income Elasticity

P e rc e n ta g e c h a n g e
in q u a n tity d e m a n d e d
In c o m e e la s tic ity o f d e m a n d =
P e rc e n ta g e c h a n g e
in in c o m e

Remember, all elasticities are


measured by dividing one
percentage change by another
 Income Elasticity
 Types of Goods
 Normal Goods
 Inferior Goods
 Higher income raises the quantity
demanded for normal goods but lowers the
quantity demanded for inferior goods.
 Income Elasticity
 Goods consumers regard as necessities
tend to be income inelastic
 Examples include food, fuel, clothing, utilities,
and medical services.
 Goods consumers regard as luxuries tend
to be income elastic.
 Examples include sports cars, furs, and
expensive foods.
 Cross-price elasticity of demand
 A measure of how much the quantity demanded
of one good responds to a change in the price of
another good, computed as the percentage
change in quantity demanded of the first good
divided by the percentage change in the price of
the second good %change in quantity demanded of good 1
Cross - price elasticity of demand 
%change in price of good 2
 Price elasticity of supply is a measure
of how much the quantity supplied of a
good responds to a change in the price
of that good.
 Price elasticity of supply is the
percentage change in quantity supplied
resulting from a percentage change in
price.
 Ability of sellers to change the amount
of the good they produce.
 Beach-front land is inelastic.
 Books, cars, or manufactured goods are
elastic.
 Time period
 Supply is more elastic in the long run.
 The price elasticity of supply is
computed as the percentage change in
the quantity supplied divided by the
percentage change in P e rprice.
c e n ta g e c h a n g e
in q u a n tity s u p p lie d
P ric e e la s tic ity o f s u p p ly =
P e rc e n ta g e c h a n g e in p ric e
 Can good news for farming be bad
news for farmers?
 What happens to wheat farmers and
the market for wheat when university
agronomists discover a new wheat
hybrid that is more productive than
existing varieties?
 Examine whether the supply or
demand curve shifts.
 Determine the direction of the shift of
the curve.
 Use the supply-and-demand diagram
to see how the market equilibrium
changes.

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