(FS) 5-Elasticity

Page 1: Elasticity

Page 2: Price Elasticity of Demand

• Definition: Measures buyers’ responsiveness to price changes.

• Types of Demand:

  • Elastic Demand:

    • Sensitive to price changes.

    • Results in a large change in quantity demanded.

  • Inelastic Demand:

    • Insensitive to price changes.

    • Results in a small change in quantity demanded.

Page 3: Price Elasticity of Demand Formula

• Formula:

  • Ed = (Percentage Change in Quantity Demanded of Product X) / (Percentage Change in Price of Product X)

Page 4: Price Elasticity of Demand Example

• Example Calculation:

  • If a cinema increases its ticket price from $10 to $11:

    • Demand falls from 3500 to 3325 customers per week.

    • Calculate PED:

      • PED = ???

Page 5: Elimination of the Minus Sign

• Explanation:

  • The inverse relationship between price and quantity demanded results in a negative elasticity coefficient.

  • Economists typically ignore the minus sign, presenting only the absolute value.

Page 6: Midpoint Formula for PED

• Standard Method:

  • Different results depending on direction of changes.

  • Example:

    • From A to B:

      • Price rises 25%, Quantity falls 33%,

      • PED = 33/25 = 1.33

    • From B to A:

      • Price falls 20%, Quantity rises 50%,

      • PED = 50/20 = 2.50

Page 7: Price Elasticity of Demand Calculation

• Equations:

  • % change in Price = (P_new - P_old) / P_old x 100%

  • % change in Quantity = (Q_new - Q_old) / Q_old x 100%

• Example:

  • Given prices and quantities, calculate PED.

    • Price increase from $200 to $250:

      • % change in P = (250-200)/200 x 100% = 25%

    • Quantity decrease from 12 to 8:

      • % change in Q = (8-12)/12 x 100% = -33.33%

    • PED = |-33.33% / 25%| = 1.33

Page 8: Interpretation of Elasticity of Demand

• Elasticity Ranges:

  • Ed > 1: demand is elastic.

  • Ed = 1: demand is unit elastic.

  • Ed < 1: demand is inelastic.

• Extreme Cases:

  • Perfectly Inelastic: Ed = 0.

  • Perfectly Elastic: Ed approaches infinity.

Page 9: Demand Curve Representation

• Graph Representation:

  • Perfectly Inelastic Demand: vertical demand curve.

  • Demand Curve Location: illustrates inelastic demand properties.

Page 10: Elastic Demand Curve Representation

• Graph Representation:

  • Perfectly Elastic Demand: horizontal demand curve.

  • Dynamics of supply and demand affected at these extremes.

Page 11: Determinants of Elasticity of Demand

• Factors Influencing Elasticity:

  • Substitutability: More substitutes yield more elastic demand.

  • Proportion of Income: Higher income proportion leads to more elastic demand.

  • Luxuries vs. Necessities: Luxury goods tend to have more elastic demand.

  • Time: Increased time for adjustment results in more elastic demand.

Page 12: More Determinants of Elasticity

• Additional Influences:

  • Habits/Addictions: Typically inelastic.

  • Complementary Goods: Generally inelastic.

  • Frequency of Purchase: Frequently bought items are often inelastic.

  • Durability: Durable goods often exhibit elastic demand.

Page 13: Total Revenue Test

• Total Revenue Formula: Total Revenue (TR) = Price (P) x Quantity (Q)

• Elasticity Effects on Revenue:

  • Inelastic Demand: Price and TR move together.

  • Elastic Demand: Price and TR move oppositely.

Page 14: Total Revenue Test Example

• Scenario Analysis:

  • Lower price with elastic demand causes a gain that exceeds loss.

  • Demonstrates the importance of elasticity in revenue.

Page 15: Inelastic Demand Example

• Scenario Analysis:

  • Lower price with inelastic demand causes loss to exceed gain.

  • Important to recognize the impact on revenue dynamics.

Page 16: Unit Elastic Demand Example

• Scenario Analysis:

  • Lower price with unit elastic demand shows gains and losses equal.

  • Indicates balance in revenue generation at unit elasticity.

Page 17: Price Elasticity of Demand for Movie Tickets

• Data Summary Table:

  1. Price and corresponding quantity of tickets demanded along with calculated elasticity and total revenue.

  2. Importance of understanding elasticity in pricing strategies.

Page 18: Elasticity and Total Revenue

• Graphical Representation:

  • Depicts the relationship between price, quantity demanded, and total revenue.

  • Differentiates between elastic, inelastic, and unit elastic demand visually.

Page 19: Summary of Price Elasticity of Demand

• Absolute Value of Elasticity Coefficient:

  • Ed > 1: Demand is elastic, total revenue decreases with a price increase and vice versa.

  • Ed = 1: Unit elastic, total revenue remains unchanged with price changes.

  • Ed < 1: Inelastic demand, total revenue increases with a price increase.

Page 20: Significance of PED

• Producers:

  • Understanding PED assists in market share and total revenue optimization.

• Government:

  • Important for predicting revenue impacts from pricing strategies.

Page 21: Price Elasticity of Supply

• Definition: Measures sellers’ responsiveness to price changes.

• Types of Supply:

  • Elastic Supply: Producers respond readily to price changes.

  • Inelastic Supply: Producers are less responsive to price changes.

Page 22: Price Elasticity of Supply Formula

• Formula:

  • Es = (Percentage Change in Quantity Supplied of Product X) / (Percentage Change in Price of Product X)

Page 23: Price Elasticity of Supply Example

• Example Calculation:

  • If market price of beans increases from $2 to $2.20, resulting in supply increase from 10,000 units to 10,500 units:

    • PES = ???

Page 24: Interpretation of Elasticity of Supply

• Elasticity Ranges:

  • Es > 1: Supply is elastic.

  • Es = 1: Supply is unit elastic.

  • Es < 1: Supply is inelastic.

• Extreme Cases:

  • Perfectly Inelastic: Es = 0.

  • Perfectly Elastic: Es approaches infinity.

Page 25: Supply Curve Representation

• Graph Representation:

  • Perfectly Inelastic Supply: vertical supply curve.

  • Supply Curve Location: illustrates inelastic supply properties.

Page 26: Elastic Supply Curve Representation

• Graph Representation:

  • Perfectly Elastic Supply: horizontal supply curve.

  • Explains responsiveness of supply based on price changes.

Page 27: Determinants of Elasticity of Supply

• Factors Influencing Elasticity:

  • Availability and Mobility: Easy relocation of production factors increases elasticity.

  • Stock Holding Ability: Type of goods affects elasticity.

Page 28: More Determinants of Elasticity of Supply

• Additional Influences:

  • Technology Advancements: Increase output flexibility, enhancing elasticity.

  • Time Dimensions: Elasticity increases with longer adjustment periods for firms.

Page 29: Significance of PES to Firms

• Importance of High PES:

  • Facilitates increased sales revenue and profits.

• Strategies for Responsiveness:i. Creating spare capacityii. Keeping large stock volumesiii. Upgrading storage systemsiv. Adopting new technologiesv. Training employees for better mobility

Page 30: Strategies for Improving PES

• Methods for Firms:

  • Implementing spare capacity and efficient stock management increases PES.

  • Embracing innovation and staff training enhances market responsiveness.

Page 31: Cross Elasticity of Demand

• Definition: Measures responsiveness of quantity demanded of one good due to a price change of another good.

• Signs:

  • Substitutes: Positive cross elasticity.

  • Complements: Negative cross elasticity.

  • Independent Goods: Zero cross elasticity.

Page 32: Visualization of Cross Elasticity

• Understanding Relationships:

  • Negative cross elasticity in complements versus positive in substitutes, illustrating varied consumer behavior.

• Independent Goods: Price changes don't affect demand.

Page 33: Cross Elasticity of Demand Calculation

• Example Scenario:

  • What is the cross elasticity of demand for Product Y when the price of Product X rises from $10 to $15?

    • Data provided for calculations of changes in quantity demanded for both products.

Page 34: Income Elasticity of Demand

• Definition: Measures buyers' response to changes in income.

• Types:

  • Normal Goods: Positive income elasticity.

  • Inferior Goods: Negative income elasticity.

• Formula:

  • Ei = (Percentage Change in Quantity Demanded) / (Percentage Change in Income)

Page 35: Summary of Cross and Income Elasticities

• Understanding Coefficients:

  • Cross elasticity indicates how quantity demanded shifts in relation to price changes of other goods.

  • Income elasticity assesses how demand shifts with income changes, clarifying responses for normal and inferior goods.