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Lecture 4.price Elasticity of Demand and Supply

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28 views15 pages

Lecture 4.price Elasticity of Demand and Supply

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mehnaz k
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© © All Rights Reserved
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PRICE ELASTICITY OF

DEMAND
CHAPTER 8
Teacher: Mehnaz Khan
Price Elasticity of Demand

Price elasticity of demand (PED) measures how the quantity demanded of a


good or service changes in response to a change in its price

Economists usually ignore the minus sign and simply present the absolute value
of the elasticity coefficient to avoid an ambiguity that might otherwise arise.
Interpretation:

•Elastic Demand (PED > 1): A small change in price leads to a


larger change in quantity demanded. Consumers are very
responsive to price changes (e.g., luxury goods).
•Inelastic Demand (PED < 1): A change in price leads to a smaller
change in quantity demanded. Consumers are less responsive to
price changes (e.g., necessities like gas or medicine).
•Unitary Elastic Demand (PED = 1): A change in price leads to a
proportionate change in quantity demanded
1.Normal Goods:
1. Definition: Goods for which demand increases when consumer income rises, and
decreases when income falls.
2. Example: Clothing, restaurant meals, and electronics.
3. Key Feature: These goods have a positive income elasticity of demand, meaning the
percentage change in demand is positive when income increases.
2.Luxury Goods (a type of normal good):
1. Definition: Goods that experience a more than proportional increase in demand as
income rises. In other words, as people become wealthier, they spend a larger
proportion of their income on these goods.
2. Example: Designer clothes, high-end cars, luxury vacations.
3. Key Feature: These goods have a high positive income elasticity of demand, and are
considered status symbols.
3.Inferior Goods:
1. Definition: Goods for which demand decreases as consumer income rises, and increases
when income falls.
2. Example: Instant noodles, public transportation, budget brand groceries.
3. Key Feature: These goods have a negative income elasticity of demand. As people earn
•Normal Goods: Moderately elastic (demand responds
to price but is not extreme).

•Luxury Goods: Highly elastic (demand is very


sensitive to price changes).

•Inferior Goods: Inelastic (demand is less responsive


to price changes).
Demand curve D1 in (a) represents perfectly inelastic demand (Ed 0). A price increase will
result in no change in quantity demanded.

Demand curve D2 in (b) represents perfectly elastic demand. Customers try to buy as much
as they can ay this price. A price increase will cause quantity demanded to decline from an
infinite amount to zero (Ed ).
FACTORS AFFECTING PRICE ELASTICITY OF DEMAND

• AVAILABILITY OF SUBSTITUTES ( IF THERE ARE LOTS OF SUBSTITUTES,


DEMAND IS ELASTIC)

• NECESSITY (GOODS CONSIDERED AS ESSENTIAL WILL HAVE INELASTIC


DEMAND)

• PERCENTAGE OF INCOME SPENT ON THAT PRODUCT (IF LARGE


PROPORTION OF INCOME IS SPENT ON THAT PRODUCT, DEMAND WILL BE
ELASTIC)

• TIME (IN SHORT RUN DEMAND IS INELASTIC AS IT TAKES CONSUMERS TO FIND


SUBSTITUTES)
Scenario:
Imagine a company sells a popular soft drink. Initially, the price of the soft drink is $2 per bottle, and consumers buy
1,000 bottles a week. Due to increased production costs, the company raises the price to $2.20 per bottle (a 10% price
increase). As a result, weekly sales drop to 900 bottles (a 10% reduction in quantity demanded).
Step 1: Calculate the Percentage Change in Price
•Initial Price: $2
•New Price: $2.20

Step 2: Calculate the Percentage Change in Quantity Demanded


•Initial Quantity Demanded: 1,000 bottles
•New Quantity Demanded: 900 bottles
•Percentage Change in Quantity Demanded:

Step 3: Calculate Price Elasticity of Demand (PED) Interpretation:


In this case, the PED is -1 (ignoring the negative sign,
which is standard since demand falls as price rises).
. This indicates unitary elastic demand, meaning that a
10% increase in price results in an exactly proportional
10% decrease in quantity demanded
Elastic vs. Inelastic Examples:

1.Elastic Demand (PED > 1):


2.For luxury items like designer handbags, a 10% increase in price
might cause a 20% drop in sales (PED = -2), as consumers have
many alternatives or can forgo the purchase.

3.Inelastic Demand (PED < 1):


For necessities like insulin, a 10% price hike might only reduce
demand by 2% (PED = -0.2), because consumers need the product
regardless of price.
(a) Price declines from $2 to $1, and total revenue increases from $20 to $40. The gain in revenue (blue
area) exceeds the loss of revenue (yellow area). (b) Price declines from $4 to $1, and total revenue falls
from $40 to $20. So demand is inelastic. The gain in revenue (blue area) is less than the loss of revenue
(yellow area)
Imagine a company sells a popular soft drink. Initially, the price
of the soft drink is $2 per bottle, and consumers buy 1,000
bottles a week. Due to increased production costs, the company
raises the price to $2.20 per bottle . As a result, weekly sales
drop to 900 bottles
Calculate the price elasticity of Demand

Ameen is selling cars. Initially the price of the car was $ 20,000.
The Quantity demanded was 6000 cars. Due to inflation price of
the car has increased to $ 23000. Quantity demanded has
decreased to 5000 cars. Calculate PED.

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