elasticity chp 4

8/4/2019 Elasticity Chp 4

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Chapter 4

Elasticity ofDemand & Supply

(c) Aidarohani Samsudin_UiTM Johor 1


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ELASTICITY OF DEMAND

Definition:

Elasticity means responsiveness orsensitivity. Therefore elasticity of demandmeans the responsiveness of demanddue to the changes of the factors thatinfluence demand.

2(c) Aidarohani Samsudin_UiTM Johor


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Types of Elasticity:

Price elasticity of demand

Cross elasticity of demand

Income elasticity of demand

Price elasticity of supply



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i. Price Elasticity of Demand (Ep) Ep measures the responsiveness of

the quantity demanded due to thechange in its price.

Ep tries to measure how much doesdemand has decreased when priceincreased



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Calculating price elasticity of demand;Formula:

Ep = - % in Qd for productX

% in P of product X= - % in Q

% in P= - Q x P0

P Q0= - (Q1 Q0) x P0

(P1 P0) Q0



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Example:

Price(RM) Quantity Demanded

2.00 10

3.00 5

Calculate the price elasticity ofdemand when price increases fromRM2.00 to RM3.00.



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Formula:Ep = - Q x P0

P Q0

= - (Q1 Q0) x P0(P1 P0) Q0= - (5 10) x 2

(3 2) 10

= 1



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Degrees of Price Elasticity of Demand

Elastic demand (Ep > 1)

Percentage change in quantity demanded

is greater then the percentage change in

price. % Q > % PP

Q

D

D



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ii. Inelastic demand (Ep < 1)

Percentage change in quantity is less thanthe percentage change in price.

% Q < % P

P

Q

D

D



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iii. Unitary elastic (Ep = 1)

Percentage change in quantity demandedis equal to the percentage change in price.

% Q = % P

D

P

X



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iv. Perfectly Elastic (Ep = )

Percentage change in quantitydemanded is infinite in relation to thepercentage change in price.

P

Q

D

P0



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v. Perfectly Inelastic (Ep = 0 )

Quantity demanded does not changeas the price changes.

P

QQ0

D

P1

P2



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Determinants of Price Elasticity of Demand Availability of substitutes

Normally, the larger the number of substitutesavailable, the greater the elasticity of demand for aproduct. When substitutes are not readily available,

the elasticity of demand is likely to be less.

Relative importance of the goods in the budget

If the goods take a large portion of an individualsbudget, the demand tends to be elastic. Examples arecars, electrical appliances and other luxury goods.Therefore a small increase in the price of the goodswill have a very large effect on the demand for the

goods. 13(c) Aidarohani Samsudin_UiTM Johor


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The amount of time available to adjust to the price

change (Time dimension)

In the short run, demand is less elastic. In the longrun demand is likely to be more elastic simplybecause consumers can make adjustment and fine

other substitutes.

The importance of goods necessity or luxury

The demand for necessity such as rice is inelastic,great increase in price will not reduce the demand forrice very much. On the other hand the demand forluxury goods or less important goods are elastic.



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Income level

Those with higher income are less sensitive to pricechanges, therefore their demand is inelastic. Whereasthose from lower income group are sensitive to price

changes and their demand is more elastic.

Habits

If goods consume becomes habits, the demand for theparticular goods are inelastic. Example is demand forcigarette by smokers.



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Relationship between price elasticity ofdemand and total revenue (TR) TR = price x quantity TR increases or decreases when there is price

changes depend on the price elasticity ofdemand.

i. If demand is elastic, to increase TR,price should be decreased.

ii. If demand is inelastic, to increase TR,price should be increased.

iii. If demand is unitary elastic, change inprice would not affect and change in TR.



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Income Elasticity of Demand (Ey) Ey measures the responsiveness of

quantity demanded to a change inincome.

Three possibilities:i. If Ey is positive = normal goods -

Ey >1 - luxuryEy 1 necessity

ii. If Ey is negative = inferior goodsiii. If Ey is zero = essentialgoods



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Formula:

Ey = % in Q

% in Y

= Q x Y

Y Q

= (Q1

Q0

) x Y0

(Y1 Y0) Q0



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Example:Income Qty A Qty B Qty C100 10 20 20120 15 20 18

150 17 20 14

Calculate the income elasticity of demandfor goods A, B and C when income

increases from RM120 to RM150.



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Good A:Ey = (QA1 QA0) x Y0

(Y1 Y0) QA0

= (17 15) x 120(150 120) 15

= 0.53

Since Ey is positive and < 1, good A is a necessity



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Good B:Ey = (QB1 QB0) x Y0

(Y1 Y0) QB0

= (20 20) x 120

(150 120) 20

= 0 (Good B is inferiorgood)



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Good C:Ey = (QC1 QC0) x Y0

(Y1 Y0) QC0

= (14 15) x 120(150 120) 15

= - 0.27

Good C is an inferior good



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Cross Elasticity of Demand (Ec) Ec measures the responsiveness of quantitydemanded for one product to a change in the price

of another product.

Qx = f(Py)

Two possibilities:Ec = +ve

- an increase in Py would increase the demandfor good x, goods x and y are substitutes

Ec = -ve

- an increae in Py would reduce the demandfor good x, goods x and y are complementarygoods.



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Formula:

Ec = % in Qx

% in Py

= Qx x Py0 Py Qx0

= (Qx1

Qx0

) x Py0

(Py1 Py0) Qx0



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Example:Price of Y Quantity x Quantity Y

RM10 60 15RM18 40 25

RM25 20 30

Calculate the cross elasticity of demand forgood x when the price of y increases from

RM18 to RM25



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Answer:Formula :

= Qx x Py0 Py Qx0

= (Qx1 Qx0) x Py0(Py1 Py0) Qx0

= 30 - 25 x 18

25 - 18 25

= 0.51

Conclusion;

If Ec is positive, goods x and y are substitutes



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Price Elasticity of Supply Measure The responsiveness of

quantity supplied to a change in price.

Elasticity of supply can be determinedby comparing the % change inquantity supplied with the % change in

the price of the product. I



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Types of Price Elasticity of Supply

Elastic Supply ( fairlyelastic)

% change inquantity supplied isgreater than %change in price.

Es =% QS > % P

S

P

Q



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2. Inelastic Supply(fairly inelastic)

% change in quantitysupplied is less than% change in price.

Es =% QS > % P Q

PS



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Unitary Elastic

% change inquantity suppliedis equal to the %change in price

Es =% QS > % PQ

S1S2



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Perfectly Inelastic

% change in quantity supplied is zerodespite the change in the price.

SP



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Perfectly Elastic

% change in quantity supplied is infinitelylarge compared to the % change in price.

Q

P

SP0



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mathematical formula

Es = % change in quantity supplied

% change in price

= % QS% P

= QS x P0

P Q0

= Q1 - Q0 x P0P1 - P0 Q0



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When the price of cars in RM 20,000 each the supply is 1000 units

per month. When price increase to RM 30,000 each, the supply is1200 units per month.Therefore, the elasticity of supply of cars is :-

= % QS

% P

= QS x P0

P Q0

= Q1 - Q0 x P0

P1 - P0 Q0

= 0.4



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Factors Influencing Elasticity of Supply

1.TIMEIn the short run, supply would be inelastic, it is notpossible to increase supply immediately in response tochange in price. However, in the long run, supply wouldbe more responsive to price changes, i.e. is more

elastic.In the long run sellers or producers can fully adjust theirsupply to the change in prices.

2.NATURE OF THE GOOD

If it takes too long to produce a product, supply is fairlyinelastic. Otherwise supply will be elastic. For example,the supply of agricultural product (primary products) isfairly inelastic whereas the supply of manufacturedgoods (secondary products) is fairly elastic.



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3.COST AND FEASIBILITY OF STORAGE

If the change in supply requires only a small change inproduction costs, most likely supply will be elastic.However if the change in supply involves a majorchange in costs supply tends to be inelastic.

Goods that are too costly to be stored will have a lowelasticity of supply.

4.SUBSTITUTABILITY OF FACTORS OR INPUTS USEDIf land, labor and capital can produce one commodity

and these factors can be readily switched to produceanother good, then supply of the factors is elastic.

But if the production of its output require veryspecialized inputs, supply tends to be more elastic.



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5. PERISHABILITYIf the product is a easily perishable,

especially agricultural product, then the

supply would be inelastic. Such productswould not be sensitive to price changes, forexample, vegetables. Hence, an increasein price will not bring about a distinctive

change or rise in the quantity supplied.

elasticity chp 4

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