Lecture 4 Elasticity

Price Elasticity

• Price elasticity of demand measures the

degree of responsiveness of qty
demanded for a good following a change
in its price.
• Ped =
% change in qty / % change in price
Price Demanded

10 200

12 160

14 110
Different Types of Elasticities
1-perfectly elastic Ped = ∞
2

2-perfectly inelastic Ped = 0

3-inelsatic 0<Ped<1
1

4 4-elastic 1<Ped< ∞
5- rectangular hyperbola
3 Ped = 1 [unitary elastic]
 Price Elasticity and Revenue
Area 0ABC = TR = OA *0C
TR is affected by Ped in the following
dd ways:
ss • For elastic dd, a change in P causes a
more than proportionate change in qty
B and hence a significant change in TR
A • For inelastic dd, a change in P causes
a less than proportionate change in
qty and hence an insignificant change
in TR
• For unitary dd, a change in P causes
an equal proportionate change in qty
0 C and hence leaves TR constant or
unchanged
Summary of effects
Changes in Elasticity Effects on Effects on
Price qty TR
Fall Elastic Large rise Increase
Rise Elastic Large fall Decrease
Fall Inelastic Small rise Decrease
rise inelastic Small fall Increase
Fall/rise one Equal unchanged
rise/fall
 Cross Price Elasticity
• Cross price elasticity
measures the degree of Nature of Xed
responsiveness of quantity relationship
dded of a product e.g A
with respect to a change in Substitutes positive
the price of a related good,
B. Complements negative
• Xed = %change in qty of A
/ %change in price of B Non-related zero

• Xed varies from -∞ to +∞

 Income Elasticity
Income elasticity measures the Characteristic of Value of Yed
degree of responsiveness of good
qty demanded with respect
to change in the income of Necessity 0< Yed<1
the consumer. normal
luxury 1< Yed<∞

Yed = % change in qty dd / %

change in income Inferior Yed <0
Exercises
• The market dd curve for jeans faced by firm A is P=600-
Q. Suppose A charges 200 fro a pair of jeans.

• Give function for TR, calculate TR

• How can you advise firm A on its pricing strategy if TR is

to be increased?
DD: Qa = 100 -2Pa +Pb+0.5Y
where Pa = 15, Pb = 5, Y= 100

• Find whether dd is elastic or not

• Find Xed
• Find Yed
• Are a and b substitutes or complements? Justify your
answer
• Is a an inferior good? Explain your answer