Elasticities
Price Elasticity of DemandIncome Elasticity of DemandCross Elasticity of Demand
Real world applications of Elasticity…
The economic concept of “Elasticity” is usedprimarily by producers to predict changes inconsumer demand.By how much will demand change if……- The price of a good increases/decreases- Consumer incomes increase/decreaseHow do I know if a good is a
compliment/substitute………..
A.S 3.2 Response of the Market to change….
“The description of how a market responds to change will involve aselection from:
Elasticity definitions of price elasticity of demand, cross elasticity of demand,income elasticity of demand and price elasticity of supply calculation of price elasticity of demand, cross elasticity of demand,income elasticity of demand and price elasticity of supply reasons for differing elasticities for different goods and services significance for firms in their pricing decisions supply responsiveness in the long term compared with the short term.”
Price Elasticity of Demand
Textbook pp. 48-55- Read & then make notes on the followingObjectives: 1. Define Price Elasticity of Demand2. Calculate Price Elasticity- Percentage Change Method & Mid Point Method3. Impact on Revenue* Calculation can be used to calculate
elasticity & the relative elasticity of a good will determine the impact on Revenue
4. Describe the different elasticities of demand5. Explain the factors that affect elasticity of demand
Price Elasticity of demand
“Measures the responsiveness of the quantity demanded of a good or service to its change in
price”
In other words if the price is increased or decreased how
much quantity demanded will change, if at all.
Calculations for Price Elasticity of Demand
Coefficient = a pure number used to quantifyElasticity
Depending on the information given there are 3methods used to calculate elasticity:- Percentage Change (Arc)- Mid Point- Change in Revenue
Percentage Change
Ep = % QD % P
Mid- Point Method
Ep = Q Q1 +Q2
2 P
P1 +P2 2
Ed = 0 < 1 InelasticEd => 1 Elastic
Ed = 0 = 1 Unitary
Revenue Change
Total Revenue 1 – Total Revenue 2Price ↓ Revenue ↑ Price ↑ Revenue ↓Price ↓ Revenue ↓Price ↑ Revenue ↑
Elastic
Inelastic
Demand Curves
What does the shape of the curve tell you?
H.E.V.I
So what does this mean?
• What kind of goods or services would have elastic demand?
• What kind of goods would have inelastic demand?
Elastic Demand
Goods & services
likely to be elastic...
Are Luxuries
Can be easily
postponed
Involve a relatively
high proportion of income
Have many close
substitutes
Inelastic Demand
Goods & services
likely to be inelastic...
Are Necessities
Can not be easily
postponed
Involve a relatively
low proportion of income
Have few close
substitutes
Elasticity in application
In class do activities 4.4 & 4.5 in your text book.
For homework do Questions: 3, 4, 7 & 8 in your workbook.
Income Elasticity of Demand & Cross Elasticity of Demand
Read pages 58-61 & then make notes which achieve the followingaims/objectives:
Define Income & Cross-Elasticity of Demand Calculate Income & Cross-Elasticity of Demand * Describe how the relative elasticity indicates if a good is Substitute or a Complement Normal Good, Luxury, Basic Necessity or an Inferior Good
* The text only has one (% ) but the mid point formula also applies
Cross Elasticity of Demand
“Cross-Elasticity of Demand measures by how much the quantity demanded of one product
will increase or decrease after a change in price of another good.”
Put simply it shows if there is a relationshipbetween goods and or services. Specifically whether they are complements orsubstitutes.
Calculations for Cross-Elasticity
Either
EC = % QB
% PA
Or
EC = QB
QB1 +QB2 2
PA
PA1 +PA2 2
Percentage Change
Mid Point Method
Implications….
A positive coefficient suggests a Substitute good or service
A perfect substitute will have a very high co-efficient
If the coefficient is 0 then there is no relationship
A negative coefficient suggests a complementary good.
Complements & Substitutes
Substitutes can be recognised by having a positive coefficientmeaning that an increase in the price of one good will result inan increase in demand for the other
Complements are recognised by having a negative coefficient,meaning that an increase in the price of one good will cause adecrease in demand for the other.
Important “Sheer coincidence” Sometimes there is no relationship
between 2 very obviously random & unconnected goods.
Aggregate Household Spending
Back in year 11 you looked at the overall patterns of householdexpenditure. Specifically identifying the pattern of consumptionOn Necessities, Luxuries, Savings, Inferior v Normal Goods.
Because Consumers are all different their tastes & preferencesand specifically spending patterns will differ. Sometimes it is notobvious or clear that a good or service is a luxury or a necessity.
The Economic Concept of Elasticity helps to identifypatterns between income & demand for specifictypes of goods & services
Calculations for Income Elasticity of Demand
Either
Ey = % QD % Y
Or
Ey = Q
Q1 +Q2 2
Y Y1 +Y2
2
Sound Familiar? The mid
point formula is basically
The same for all elasticity
calculations. Quantity
Will always sta
y on top
Implications…
A positive coefficient suggests a Normal Good
A very high coefficient suggests a luxury good
A coefficient which is less than one suggests a
good is a necessity
A negative coefficient suggests an inferior good,
sometimes known as a Giffen Good.
Types of Goods & Services…. Normal. Goods or services that are slightly better quality.Demand for normal goods will increase as income increases. LuxuryGoods or services that are “treats, obtained via discretionaryincome. Demand will increase with an increase income NecessityBasic goods or services that vital or needed for survival. Inferior (Griffin Goods)Low quality, budget brand goods. When income increases,demand will decrease
Applying it….
Do activity 4.6 on p. 57/58 (Good real worldexample ;-)
Then also add to homework/do workbookquestionsIncome Elasticity – p. 26 Q. 12,13 & 15Cross Elasticity – p. 28 Q. 19, 20For fun …. Multiple Choice p. 29/30