1

Business Economics (ECO 341)Fall Semester, 2012

Khurrum S. Mughal

Price Elasticity of Demand

Price Elasticity of Supply

Uses of Elasticities

Theme of the Lecture

2

How are price and demand related for a good? (law of demand)

Consumer Demand Theory Qd= f(Px, I, Py,T)

Assuming everything else fixed…………….

Individual Demand

3

Demand function faced by a firm

QD= a0+a1Px +a2I+a3N+a4Py+ a5T……………

“a” is coefficient to be estimated with regression

analysis

Demand Faced by A Firm

4

Measures responsiveness to changes in quantity demanded

due to changes in price

Percentage change in quantity due to percentage change in price

Different effects of reducing price

Types:

Point Price Elasticity of Demand

Arc Price Elasticity of Demand

Price Elasticity of Demand

5

Graphical Representation

Different at different points

Given by coefficient “a” with Price in the

regression equation

Point Price Elasticity of Demand

6

Graphical Representation

Used since Point price elasticity differs in

scenarios of price rise and fall

Calculated by average of change in quantity

and price

In general: the price elasticity of demand for

a firm is higher than the price elasticity of

market demand

Arc Price Elasticity of Demand

7

Price Elasticity of Demand

8

Quantity Supplied and Demanded

Pri

ce

Ed > 1

Ed < 1

Ed = 1

Polar Extreme Cases of Price Elasticity of Demand

9

Quantity Supplied and Demanded

Pri

ce Perfectly Inelastic Demand

Perfectly Elastic Demand

Price Elasticity, Total Revenue

10

P ($) Q Ep TR=P.Q

6 0 -∞ 0

5 100 -5 500

4 200 -2 800

3 300 -1 900

2 400 -0.5 800

1 500 -0.2 500

0 600 0 0

Effect of decrease in price on Total revenue:

Increases if demand is elastic

Remains Unchanged if Unitary elastic

Decreases if Inelastic

Graphical Representation:

Price Elasticity, Total Revenue

11

Availability of Substitutes

Example: Sugar vs Salt

Larger for longer time periods

Example: Petrol vs CNG

Factors Effecting Price Elasticity of Demand

12

Price Elasticity of Demand

Price Elasticity of Supply

Uses of Elasticities

Theme of the Lecture

13

The quantity sellers are willing to sell at a given price

level

Depends on:Price of the commodity

Prices of inputs

Technology

Opportunity cost

Future expectations

Number of sellers

Supply of a Commodity

14

The higher the price, greater is the quantity sellers are willing to sell in the market (law of supply)

Assuming everything else is fixed………

Individual Supply

15

Measures responsiveness to changes in quantity

supplied due to changes in pricePercentage change in quantity due to percentage

change in price

Factors Effecting elasticity of supplyAbility to increase production

Time Period

Price Elasticity of Supply

16

Polar Extreme Cases of Price Elasticity of Supply

17

Perfectly Inelastic Supply

Perfectly Elastic Supply

Quantity Supplied and Demanded

Pri

ce

Quantity Supplied and Demanded

Pri

ce

Initial Demand

New Demand

Initial Demand

New Demand