PENGANTAR ILMU PENGETAHUAN SOSIAL II OPENCOURSEWARE UNIVERSITAS PEMBANGUNAN JAYA Slide LSE 2 Ekonomi
Price Elasticity of Demand
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?
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
Elasticity
4 basic types used:
Price elasticity of demand
Price elasticity of supply
Income elasticity of demand
Cross elasticity
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
Elasticity
Price ($)
The demand curve can be a
range of shapes each of which
is associated with a different
relationship between price and
the quantity demanded.
Quantity Demanded
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)
Elasticity
Price
Total revenue is price x
The importance of elasticity
quantity sold. In this
is the information it
example,
TRthe
= £5
x 100,000
provides on
effect
on
=
£500,000.
total revenue of changes in
price.
This value is represented by
the grey shaded rectangle.
$5
Total Revenue
D
100
Quantity Demanded (000s)
Elasticity
Price
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
$3
Total Revenue
D
100
140
Quantity Demanded (000s)
Elasticity
Price ($)
Producer decides to lower price to attract sales
10
% Δ Price = -50%
% Δ Quantity Demanded = +20%
Ped = -0.4 (Inelastic)
Total Revenue would fall
5
Not a good move!
D
5 6
Quantity Demanded
Elasticity
Price ($)
Producer decides to reduce price to increase sales
% Δ in Price = - 30%
% Δ in Demand = + 300%
Ped = - 10 (Elastic)
Total Revenue rises
10
Good Move!
7
D
5
Quantity Demanded
20
The Meaning of Price Elasticity
of demand
Elastic Demand: A strong response to a ch
Unit Elastic demand: A proportional respons
change (total amount spent by consumers
unchanged)
Inelastic demand : A weak response to a pr
Elasticity
If demand is
price elastic:
Increasing price
would reduce TR
(%Δ Qd > % Δ P)
Reducing price
would increase TR
(%Δ Qd > % Δ P)
If demand is
price inelastic:
Increasing price
would increase TR
(%Δ Qd < % Δ P)
Reducing price
would reduce TR
(%Δ Qd < % Δ P)
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
Elasticity and Total Outlays
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.
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.
Review Question
1 and 2 pg 86
Factors affecting elasticity of
demand
Whether the good is a luxury or a necessity.
-necessities have relative inelastic demandeven 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
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
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.
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
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
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?
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
Elasticity
4 basic types used:
Price elasticity of demand
Price elasticity of supply
Income elasticity of demand
Cross elasticity
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
Elasticity
Price ($)
The demand curve can be a
range of shapes each of which
is associated with a different
relationship between price and
the quantity demanded.
Quantity Demanded
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)
Elasticity
Price
Total revenue is price x
The importance of elasticity
quantity sold. In this
is the information it
example,
TRthe
= £5
x 100,000
provides on
effect
on
=
£500,000.
total revenue of changes in
price.
This value is represented by
the grey shaded rectangle.
$5
Total Revenue
D
100
Quantity Demanded (000s)
Elasticity
Price
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
$3
Total Revenue
D
100
140
Quantity Demanded (000s)
Elasticity
Price ($)
Producer decides to lower price to attract sales
10
% Δ Price = -50%
% Δ Quantity Demanded = +20%
Ped = -0.4 (Inelastic)
Total Revenue would fall
5
Not a good move!
D
5 6
Quantity Demanded
Elasticity
Price ($)
Producer decides to reduce price to increase sales
% Δ in Price = - 30%
% Δ in Demand = + 300%
Ped = - 10 (Elastic)
Total Revenue rises
10
Good Move!
7
D
5
Quantity Demanded
20
The Meaning of Price Elasticity
of demand
Elastic Demand: A strong response to a ch
Unit Elastic demand: A proportional respons
change (total amount spent by consumers
unchanged)
Inelastic demand : A weak response to a pr
Elasticity
If demand is
price elastic:
Increasing price
would reduce TR
(%Δ Qd > % Δ P)
Reducing price
would increase TR
(%Δ Qd > % Δ P)
If demand is
price inelastic:
Increasing price
would increase TR
(%Δ Qd < % Δ P)
Reducing price
would reduce TR
(%Δ Qd < % Δ P)
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
Elasticity and Total Outlays
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.
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.
Review Question
1 and 2 pg 86
Factors affecting elasticity of
demand
Whether the good is a luxury or a necessity.
-necessities have relative inelastic demandeven 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
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
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.
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
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