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ELASTICITY
Ms. Tai Nyuk Chin
LEARNING OUTCOMES
At the end of this lesson, the students should be able to: i. Explain the concept of elasticity. ii. Identify the types of elasticity. iii. Identify the determinants of elasticity of demand and supply. iv. Define and calculate elasticity of demand (price, income, cross) and supply.
ELASTICITY
Four types of Elasticity: i. Price Elasticity of Demand ii. Income Elasticity of Demand iii. Cross-Price Elasticity of Demand iv. Price Elasticity of Supply
2. Measurement :
Ed =
percentage change in demand percentage change in price
Ed =
Q1 = Current quantity Qo = base year quantity
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:
% Qd > %P
Elasticity, Ed>1
$5 4 1. A 25% increase in price . . . Demand
50
100
Quantity
90
100
Quantity
(c) Perfectly Elastic Demand: Elasticity Equals Infinity Price 1. At any price above $4, quantity demanded is zero. $4 2. At exactly $4, consumers will buy any quantity. Demand
Elasticity, Ed =
Quantity
Elasticity, Ed = 0 %P, %Q = 0
4
1. Any increase in price . . .
100
Quantity
Elasticity, Ed = 1 %P = %Q
$5
4
1. A 25% increase in price . . . Demand
80
100
Quantity
$4
P Q = $400 (revenue)
Demand
0 Q
100
Quantity
Figure 12 How Total Revenue Changes When Price Changes: Inelastic Demand
$3
Figure 13 How Total Revenue Changes When Price Changes: Elastic Demand
Price
An Increase in price from $4 to $5
Price
leads to an decrease in total revenue from $200 to $100
$5
$4 Demand Revenue = $200 Revenue = $100 Demand
50
Quantity
20
Quantity
Elasticity measure that looks at the impact of a change in the price of one good has on the demand of another good. Positive: P of Good A increase, Qdd of Good B increase (Substitutes goods) Negative: P of Good A increase, Qdd of Good B decrease (Complement goods)
Ec =
x 100
The Cross Price elasticity of demand for good X if price of Good X increase from RM10 to RM12:
Good X and Good Y:
Ec =
(110 -100 / 100)x 100 ( 12-10/10) x 100 = [10/ 20] = 0.5 (Substitutes good) :. Positive value indicates that good X and Good Y is a substitutes goods
(70 -100 / 100) x 100 (12-10/10) x 100 = [-30/ 20] = - 1.5 (Complement good) :. Negative value indicates that Good X and Good Z is a complement goods Ec =
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.
Ey = [(Q1-Q0/Q0)]
[(Y1-Y0/Y0)]
x 100 x 100
100
150
100
110
100
70
The income elasticity of demand for good X if income increase from RM100 to RM150:
The income elasticity of demand for good Y if income increase from RM100 to RM150:
[(110 -100) / 100] x 100 [ (150-100)/100]x 100 = [10/ 50] = 0.2 (Normal good) :. Positive value of Ey indicates that good X is a normal goods. :. If income increases by 1%, quantity of good X demanded will increase by 0.2%
Ey =
[(70 -100) / 100] x 100 [(150-100)/100] x 100 = (-30/50 ) = - 0.6 (Inferior good) :. Negative value of Ey indicates that good Y is a inferior goods. :. If income increases by 1%, quantity of good Y demanded will decrease by 0.6%
Ey =
Es =
Es =
Q1 = Current quantity Qo = base year quantity
[(Q1-Q0/Q0)] [(P1-P0/P0)]
(a) Elastic Supply: Elasticity Is Greater Than 1 (Es > 1) Price Supply $5 4 1. A 25% increase in price . . .
%P < %Q
100
200
Quantity
(b) Inelastic Supply: Elasticity Is Less Than 1 (Es <1) Price Supply $5 4 1. A 25% increase in price . . .
100
110
Quantity
(c) Perfectly Elastic Supply: Elasticity Equals Infinity (Es = ) Price 1. At any price above $4, quantity supplied is infinite. $4 2. At exactly $4, producers will supply any quantity.
Supply
Quantity
(d) Perfectly Inelastic Supply: Elasticity Equals 0 (Es = 0) Price Supply $5 4 1. An increase in price . . .
100
Quantity
100
125
Quantity
In long term, elasticity of supply is usually more elastic than in short term. In short term, firm cannot easily change the quantity of goods they wanted to produce and this makes them less responsive to price changes. In long term, producers can change the quantity supplied as they possess more time to response to price changes.