8/21/2019 MN 304 - Elasticity - 3

1/39

1

Elasticity of Demand

 

Elasticity means the measurement of responsiveness 

of one variable to other variable.

X =f (Y), X = dependent variable, Y = Independent

variable (If Y change ho it is going to affect

for X ! elasticity measure it)

  "n elasticity of demand = (# change in thedemand for good ")$# change in an

independent variable

%ain Demand Elasticities

&rice elasticity of demand

'ross price elasticity of demand

Income elasticity of demand

8/21/2019 MN 304 - Elasticity - 3

2/39

2

ther Elasticities

 upply elasticity

 "dvertising and cross

advertising elasticity

'on*ectural price elasticity

Imports and e+ports elasticities

8/21/2019 MN 304 - Elasticity - 3

3/39

3

 

&rice elasticity of demand (the percentage change in

the uantity of a good demanded divided by the

corresponding percentage change in its price. -his is

related ith the movement along the demand curve)

&oint elasticity = "# = "$ = " X &

  "& # "&$& " &

8/21/2019 MN 304 - Elasticity - 3

4/39

4

Elasticity measure gives to pieces of information/

• It shos sign of the relationship beteenchanges in the relevant variables.

• It measures the e+tent to hich uantity

responds to a change in price.

0enerally price elasticity can be in three ranges/

1. &rice inelastic ( 2 ! 1), Ed 3 1

4. 5nitary (1), Ed = 1

6. &rice elastic (1 and infinity), Ed 7 1

8/21/2019 MN 304 - Elasticity - 3

5/39

5

 

"rc elasticity  allos you to calculate elasticity in to

price and to uantity combinations

  Change in Q Q2-Q1  Average Q = (Q2+Q1)/2 = A Q . P2+P1

  Change in P P2-P1 A P Q2+Q1

  Average P (P2+P1)/2

Price

Quantity

demanded0Q1 Q2

P1

P2

A P

AQ

C

A

B

8/21/2019 MN 304 - Elasticity - 3

6/39

6

Elasticity along a linear demand curve

 

Qd0

Ed = 00 : Perect e!a"tic

Ed # 1 : E!a"tic range

Ed = 1 : P$int $ unitary e!a"ticity

Ed % 1 : &ne!a"tic range

Ed = 0 : Perect ine!a"tic

P

8/21/2019 MN 304 - Elasticity - 3

7/39

7

0raphical 8epresentation of Elasticity

1. 5nitary Elasticity

Qd

P2 

P1

Q1 Q2  0 

DP

D

5%

5%

P up 5% Qd 5%

down

P down 5% Qd 5%

up

8/21/2019 MN 304 - Elasticity - 3

8/39

8

4. Inelastic situation

(relative)

P up 20% Qd 5%

down

P

P2 

Q1 Q2 

D

P1

0

D1

20%

5% DQd

Large range of price changes but

Small changes of quantity of eman

8/21/2019 MN 304 - Elasticity - 3

9/39

!

6. Elastic situation

(relative)

P up 5% Qd 20%

Down

P

P2 

Q1 Q2  

D

P1

0

20%

5%

D

Qd

Small range of price changes but

massi"e changes of quantity of eman

8/21/2019 MN 304 - Elasticity - 3

10/39

1#

9. &erfect Inelastic situation

P

P3

Q1

P1

0

D

Qd

P2 

8/21/2019 MN 304 - Elasticity - 3

11/39

11

:. &erfect Elastic situation

P

P 

Q1 Q2  0

D

Qd

8/21/2019 MN 304 - Elasticity - 3

12/39

12

;actors affect for the price elasticity 

$ime perio %more time lesser elasticity&

aicti"e nature for goo'ser"ices %more

aiction lesser elasticity&

a"ailability of substitutes an their quality

price range( an the necessity of the goos

share of income spent on goo

consumers ability to change his en"ironment

8/21/2019 MN 304 - Elasticity - 3

13/39

13

Importance of price elasticity 

• to etermine pricing policies'strategy

• to select inputs

• to select mar)ets

• to ma*imi+e re"enue

• to go"ernment ta*ation policies

;irm and the mar

8/21/2019 MN 304 - Elasticity - 3

14/39

14

'ross elasticity of Demand

$his is relate 0ith the shift in eman cur"e t can beefine as the responsi"eness of eman for one prouct to

changes in prices of other prouct

* % change in quantity emane of goo &'% change

in price of & 

Ep+ = "y . &+

  "&+ &y

8/21/2019 MN 304 - Elasticity - 3

15/39

15

Importance

to chec< the impact of prices of other goods to

the good concerned

to formulate a good pricing strategy

to analyse ris

8/21/2019 MN 304 - Elasticity - 3

16/39

16

ature of 'ross &rice Elasticity

1) 'ross price elasticity for substitute goods

are positive

4) 'ross price elasticity for complement

goods are negative

6) 'ross price elasticity for independentgoods are >ero

8/21/2019 MN 304 - Elasticity - 3

17/39

17

Cr$""-Price Ed = ' change in demand $r $n r$duct  ' change in rice $ an$ther r$duct

omplements an Substitutes

Cr$"" Ed % 0 (-)*C$m!ement"

e.g.1. ,, demand ri"e" a"

rice $ ,, machine" dec!ine"e.g.2. ,emand $r !ight" t$

Canary &"!e" $ver 2 a!! a"

rice $ acc$mm$dati$n ri"e"

Cr$"" Ed # 0 (+)*u"titute"

e.g.1. i"e in rice $ etr$!

increa"e" demand $r u!ictran"$rt

e.g.2. 3a!! in rice $ m$i!e

h$ne" decrea"e" demand $r

!and !ine"

8/21/2019 MN 304 - Elasticity - 3

18/39

18

E = AQ .

  A Q

Income Elasticity of demand

4hi" mea"ure" the re"$n"ivene"" $ 5uantity demanded t$

change in inc$me6 h$!ding $ther act$r" are c$n"tant.

4hi" re!ated ith the "hit in demand curve due t$ change" in

inc$me.

3$r n$rma! g$$d" thi" i" $"itive and $r ineri$r g$$d" thi" i"

negative

&m$rtance (t$ chec7 uture demand6 deci"i$n" $ninve"tment6 $!icy deci"i$n" in internati$na! trade6 eect" $

change" in rea! inc$me)

E!a"ticity can e mea"ure $r $ther varia!e" "uch a"

adverti"ing and intere"t rate"6 etc.

Ey = % change in quantity demanded

  % change in disposable Y 

8/21/2019 MN 304 - Elasticity - 3

19/39

1!

Income and Elasticity ! 8elationship

Income Income

Elasticity 3 2

Income Elasticity = 2

Income Elasticity72

Demand  2

"

? " = ormal good, " ! Y = Inferior good

 Y

d

8/21/2019 MN 304 - Elasticity - 3

20/39

2#

8elationship beteen -8, "8 and %8

-otal 8evenue = -8 = & .

 "erage 9e"enue- $9': ; :': 9 ;

.arginal 9e"enue- %$9&'%:& .9

"ngel@s Aa

4he r$$rti$n" $ e8enditure $n a!! nece""itie" ($$d") dec!ine"

a" inc$me" ri"e and in c$ntra"t the r$$rti$nate e8enditure $n !

u8urie" (dura!e) $u!d increa"e. (thi" i" re!ated ith the c$n"um

er9" ahavi$ur ith inc$me increa"e")

8/21/2019 MN 304 - Elasticity - 3

21/39

21

$he effect on re"enue of a price

change

at $int y6 Ed = 1

eteen 8 and y6 Ed # 1

eteen y and 6 Ed % 1

eteen 8 and y6 4increa"e" (i.e. ; i" +ve)

at y 4 i" at it" ma8imum(i.e. ; = 0)

eteen y and 6 4decrea"e" (i.e. ; i" -ve)

quantity

  p  r   i  c  e

   (   £   )

quantity

   t  o   t  a   l  r  e  v  e  n  u  e

   (   £   )0

0

MR 

AR 

x

y p*

z

q*

lastic 9ange

8/21/2019 MN 304 - Elasticity - 3

22/39

22

ncome lasticity / *amples %Loo)ing at this coefficient name 0hich

goo is =ormal an inferior&

?@)

change ine8enditure

(')

&nc$mee!a"ticity $

demand

1>?1 1>>1

Car" A $ther vehic!e" 7,754 10,657 3744 1!5

3urniture A 3!$$r c$vering" 4,031 4,"#3 !13" 07!

3$$d 30,!17 33,40# 1056 035

Beer ",561 ",!11 $40# $014

ther a!c$h$!ic drin7 6,363 7,616 1#6# 066

4$acc$ ",167 6,56# $1#57 $066C!$thing #,563 14,410 50!1 16"

3$$tear !,1#5 !,"#5 31"# 107

Energy r$duct" 17,31# !1,331 !316 07"

note &n the same pe'iod, 'eal national disposable income 'ose by !#"6%source : Pass & Lowes (1994)

8/21/2019 MN 304 - Elasticity - 3

23/39

23

u!y E!a"ticity(his al)ays should go )ith lag &* p'ice changes it ta+es sometime to

'espond supply to p'ice changes in some secto's

Es = % change in quantity supplied% change in p'ice

s > 1(

lastic

s ? 1( nelastic

S

S

S

s 1(

8/21/2019 MN 304 - Elasticity - 3

24/39

24

"dvertising Elasticity

  measure of the effect of a change in a"ertising upon the

sales of a gi"en gooa % change in quantity emane of goo &'% change

in e*peniture on a"ertising goo &

f a >1- nelastic %large amount of e*peniture neee to

increase eman&f a?1- lastic %small amount of e*peniture neee to

increase eman&

'ross "dvertising Elasticity

  measure of the responsi"eness of the quantity of eman

of one goo to a change in the e*peniture upon a"ertising

on another goo ;ositi"e for complements an negati"e for

substitutes

8/21/2019 MN 304 - Elasticity - 3

25/39

25

'on*ectural &rice Elasticity

$his measures interepenence bet0een firms an

a goo measure to forecast price changes in

retaliation specially in oligopolistic mar)ets $his 0il

l help to firm@s pricing ecision ma)ing strategy

c %*pecte change in the price charge by

firm &'%ctual change in price charge by firm

&

8/21/2019 MN 304 - Elasticity - 3

26/39

26

E+ports and Imports Elasticity

;rice elasticity of eman for e*ports % change in the

eman for e*ports in country *' change in price of e*ports in country &

ncome elasticity of eman for e*ports % change in

the eman for e*ports in country *' change in isposabl

e income abroa&

;rice elasticity of eman for imports % change in the

eman for imports in country *' change in price of impo

rts in country &

ncome elasticity of eman for imports % change in

the eman for imports in country *' change in isposab

le income aboar&

$hese elasticities are important to policy ecisions in

e*ternal trae an e"aluation

8/21/2019 MN 304 - Elasticity - 3

27/39

27

Demand Estimation

Identification of firm@s real demand curve helps todetermine

  the correct price,

  inputs reuirements  profit ma+imising output

Identification of demand

  'onsumer intervies  'onsumer surveys  'onsumer clinics and focus groups  %ar

8/21/2019 MN 304 - Elasticity - 3

28/39

28

tatistical Estimation of Demand

8egression techniue (Identification ofvariables, obtain data on variables, euation

specification, estimation of regression

parameters, interpretation of regression

results/ coefficient of determination, ; and t

statistics, E, problems of regression/

"uto correlation, multi!collinearity,

heteroscedasticity).

 

8/21/2019 MN 304 - Elasticity - 3

29/39

2!

Demand ;orecasting %ethods• ,eterministic $ime Series nalysis %secular tren(

cyclical fluctuation( seasonal "ariation an ranominfluences&• $ren proAection( e*trapolation or cur"e fitting• arometric or lag or lea inicator methos• conometric moels %Single( multiple( lag( structural

moelBetc&• nputCoutput analysis %interrelationships&• Dpinion polling an sur"ey techniques %future plans&

  $echniques selection epens on the forecastingistance( comple*ity of the forecasting problem( lea

time( accuracy( relationship( resources an time

a"ailability( etc

&rod ct Aife ' cle

8/21/2019 MN 304 - Elasticity - 3

30/39

3#

&roduct Aife 'ycle4hi" "h$" $ur "tage" $ demand $r a r$duct.

&ntr$ducti$n ha"e - demand increa"e" "!$!y.

8/21/2019 MN 304 - Elasticity - 3

31/39

31

'haracteristics "pproach to Demand

-his  says that consumers are demanded goods

because of their characteristics rather than consumers

on sa

8/21/2019 MN 304 - Elasticity - 3

32/39

32

;ar7et egmentati$n

egmentati$n i" the r$ce"" $ "!icing a mar7et $r a articu!ar r$duct $r "ervice int$ a

numer $ dierent "egment". 4he "egment" are u"ua!!y a"ed $n act$r" "uch a"

dem$grahic"6 e!ie" $r the $cca"i$n $ u"e $ the r$duct.

;ar7et "egment" $r niche" are gr$u" $ c$n"umer" ith "imi!ar ta"te" and reerence

attern". ;a8imum numer $ mar7et "egment" i!! n$t e8ceed the numer $ $tentia!cu"t$mer".;ar7et can e "egmented acc$rding t$ r$duct characteri"tic"6 c$n"umer inc$me!eve!6 age and ge$grahic area. E!a"ticitie" can he! t$ identiy mar7et "egment".

egmentati$n can aid in: identiying c$metit$r"6 ne r$duct deve!$ment6

targeting adverti"ing e8enditure6 randing and e8!$iting mar7et niche".

4he internet r$mi"e" t$ r$vide ne $$rtunitie" $r "egmentati$n. &t $er"

c$ntinu$u" $$rtunitie" t$ cature in$rmati$n a$ut cu"t$mer ehavi$ur.

C$n"umer" identiy them"e!ve" and their characteri"tic" y their e!ectr$nic

articiati$n in articu!ar intere"t gr$u"6 and y their genera! $n!ine ehavi$ur.

8/21/2019 MN 304 - Elasticity - 3

33/39

33

%ar

8/21/2019 MN 304 - Elasticity - 3

34/39

34

Segmentation *ample 1 - eer  

Beer 'ategory

9C#

:1#

Ales Lagers

• Which are the growing product

eg!ent through the "##0$• %n which product eg!ent are

 &randing and advertiing !ot

i!portant$

8/21/2019 MN 304 - Elasticity - 3

35/39

35

egmentation E+ample 4 / &aint

'pecialied

(aint

)ecorative paint %ndutrial paint

vera!! mar7et

Br$ad "ect$r"

;aH$r u"er" )% (ro+eional

)ecorator

,eneral

%ndutrial

Pr$duct gr$u (ri!er Matt ,lo 'pecial(urpoe etc-

Pr$duct !ine .aic )e /uxe 'uper de luxe

C$!$ur range White .lue Red etc-

Pac7aging an1&ruh Aerool 2ray1roller  

,i"triuti$n $ut!et" Wholealer Retailer  

8/21/2019 MN 304 - Elasticity - 3

36/39

36

'riticism about demand theory

1& onsumers rationality is unpractical

2& ,eman not al0ays beha"e as it is state in

the la0

3& ;rice is not the main concern of consumer

$hey concern about quality( reliability( esign( afte

r sales ser"ices( bran names( recommenations

from friens( pre"ious e*perience( consumer guies( a"ertisements( etc

8/21/2019 MN 304 - Elasticity - 3

37/39

37

1& Self CStuy

,eman stimation

1& Specify the eman function for the follo0ing

proucts2& Eo0 o you estimate mar)et eman for thefollo0ing prouctsF

1) a ne version of %icrosoft ffice

4) a ne brand of toothpaste6) internet ban< accounts

9) car e+haust systems

:) theatre performances

) a ne toll roadF) electricity supply

G) ri Aan

8/21/2019 MN 304 - Elasticity - 3

38/39

38

uestions to discuss

E+plain mar

8/21/2019 MN 304 - Elasticity - 3

39/39

8eferences

Chater I and J in ;c