Week 4 - Elasticity_PED & PES & YED & XED

Introduction to Price Elasticity of Demand and Supply

• Price Elasticity of Demand (PED): Measures how much the quantity demanded of a good changes in response to a change in its price.

• Price Elasticity of Supply (PES): Measures how much the quantity supplied of a good changes in response to a change in its price.

Learning Objectives (2024-25 DMUC)

• Understanding PED:

  • Explain the concept of PED.

  • Calculate PED and interpret the results.

  • Discuss factors influencing demand and implications for consumers, firms, and governments.

• Understanding PES:

  • Calculate PES, identify elastic and inelastic supply, and recognize the speed of supply adjustment.

Demand Factors and Elasticity

• Necessity vs. Luxury Goods:

  • Necessities (e.g., gas) have inelastic demand; luxury goods (e.g., watches) have elastic demand.

• Substitutes:

  • More substitutes lead to more elastic demand.

  • Examples include gasoline brands with close substitutes vs. insulin.

• Income Proportion:

  • Smaller proportion of income spent results in lower elasticity. Changes in price have less impact on the consumer's budget.

• Time Factor:

  • Demand is generally more inelastic in the short run but can be more elastic over time.

• Market Definition:

  • Narrowly defined goods tend to be more elastic; broadly defined goods tend to be inelastic.

Measuring Price Elasticity of Demand (PED)

• Formula:

  • PED = % Change in Quantity Demanded / % Change in Price.

• Elasticity Categories:

  • Elastic Demand (|PED| > 1)

  • Inelastic Demand (|PED| < 1)

  • Unit Elastic Demand (|PED| = 1)

• Demand Curve Behavior:

  • Elastic segment: Small price change leads to large quantity demanded change.

  • Inelastic segment: Price change results in little quantity demanded change.

  • Perfectly inelastic: Demand remains constant regardless of price.

  • Perfectly elastic: Any price change results in zero quantity demanded.

Total Revenue and PED

• Total Revenue:

  • TR = Price × Quantity Sold.

• Impact on Revenue:

  • Elastic Demand: Price decrease increases total revenue; price increase decreases total revenue.

  • Inelastic Demand: Price increase increases total revenue; price decrease decreases total revenue.

• Graphical Analysis:

  • Steeper curves indicate inelasticity; flatter curves indicate elasticity.

Price Elasticity of Supply (PES)

• Formula:

  • PES = % Change in Quantity Supplied / % Change in Price.

• Supply Elasticity Coefficients:

  • Inelastic: < 1; Elastic: > 1; Unitary: = 1.

• Factors Influencing PES:

  • Spare capacity: Firms with spare capacity can produce more easily, leading to elastic supply.

  • Production time: Longer production times make supply inelastic.

  • Production switch ease: Easier switching between products increases elasticity.

  • Storage capability: Products that can be stored have more elastic supply.

• Elasticity Over Time:

  • PES can become more elastic as time allows firms to adjust their production capacity.

Practice Activities

• Activity 1: Analyze consumer behavior concerning price changes (AEON Mall example).

• Activity 2: Discuss demand changes in the UK energy market between 2021 and 2022.

• Activity 3: Calculate PED for tea bags after a price change.

• Activity 4: Calculate PED for optical glasses after a price increase.

Homework and Extensions

• Engage with extra resources to deepen understanding of price sensitivity and elasticity.

• Suggested reading: "The Shackled Continent" by Robert Guest for practical economic examples.