Price ElasticityIncome Elasticity

Managerial EconomicsPresented by: April Love Nuqui

Flow of Presentation

- Concept of Elasticity- Price Elasticity of Demand- Income Elasticity of DemandPrice Elasticity of SupplyImportance in Economic Theory and Practice- Summary

ObjectivesBe able to:Understand the concept of price elasticity and income elasticity. Calculate the elasticity using the given formula.Interpret the meaning of the elasticity value derived from the calculations performed.Apply the knowledge of elasticity to practical uses.

Did you know? Elasticity in PHYSICSThe ability of a body to resist a distorting influence or stress and to return to its original size and shape when the stress is removed.

Did you THINK about these?Price Elasticity

Elasticity the conceptThe responsiveness of one variable to changes in anotherWhen price rises what happens to quantity demanded?Demand fallsBUT!How much does demand fall?

Elasticity the conceptIf price rises by 10% - what happens to quantity demanded (Qd)?We know Qd will fallBy more than 10%?By less than 10%?Elasticity measures the extent to which quantity demanded will change

ElasticityBasic types used:

Price elasticity of demand PED

Price elasticity of supply PES

Income elasticity of demand YED

PRICE ELASTICITY OF DEMANDThe ratio of the percentage change in the quantity demanded to the percentage change in price.What Is the Price Elasticity of Demand Used For?It measures the size of the change in quantity demanded when the price of a good changes.

Did you know?Alfred Marshall(26 July 1842 13 July 1924)Devised Price Elasticity of Demand

Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones then your elasticity of demand would be calculated as:PRICE ELASTICITY OF DEMAND

PRICE ELASTICITY OF DEMANDHow is it Calculated?Mid-point method

Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones the your elasticity of demand, using the midpoint formula, would be calculated as:PRICE ELASTICITY OF DEMAND

PRICE ELASTICITY OF DEMANDWhy Do Economists Use Elasticity to Measure the Size of the Change?

Because elasticity is a ratio of two percentages.

Allows us to compare the demands for different goods.

PRICE ELASTICITY OF DEMANDWhat Does the Elasticity Number or Coefficient Mean?The absolute value of the elasticity coefficient shows whether the quantity change is bigger than the price change, the same size as the price change, or smaller than the price change.

The bigger the absolute value, the more sensitive or responsive consumers are to a price change.

The smaller the absolute value, the less sensitive or responsive they are to a price change..

PRICE ELASTICITY OF DEMANDTYPES OF ELASTICITY

Hypothetical Demand Elasticity for Four Products PRODUCT % CHANGE INPRICE (% DP)% CHANGE IN QUANTITY DEMANDED (% DQD) ELASTICITY (% DQD %DP)Insulin+10%0%0.0Perfectly inelasticBasic telephone service+10%-1%-0.1InelasticBeef+10%-10%-1.0Unitarily elasticBananas+10%-30%-3.0Elastic

Price Elasticity of Demand

Perfectly Inelastic Demand- Elasticity equals 0QuantityPrice2. ...leaves the quantity demanded unchanged.

Inelastic Demand- Elasticity is less than 1QuantityPrice

Unit Elastic Demand- Elasticity equals 1QuantityPrice

Elastic Demand- Elasticity is greater than 1QuantityPrice

Perfectly Elastic Demand- Elasticity equals infinityQuantityPrice

Elasticity Versus SlopeElasticity of demand describes the shape of a demand curve, but it is not the same as slope.Slope measures the rise or fall in a curve divided by its horizontal run.Elasticity measures the horizontal run by the rise or fall.

PRICE ELASTICITY OF DEMAND

Price Elasticity of Demand and Total RevenueTotal Revenue (TR) of a seller equals the price of a good times the quantity of the good sold.Total revenue may increase, decrease or remain constant.If demand is elastic, a price rise decreases total revenue.If demand is elastic, a price fall increases total revenue.If demand is inelastic, a price fall decreases total revenue.If demand is unit elastic, a price fall will sell more goods while total revenue remains constant.

Elasticity and Total RevenueTotal revenue is the amount paid by buyers and received by sellers of a good.Computed as the price of the good times the quantity sold. TR = P x Q

ElasticityPriceQuantity Demanded (000s)DThe importance of elasticity is the information it provides on the effect on total revenue of changes in price.P5100Total revenue is price x quantity sold. In this example, TR = P5 x 100,000 = P500,000.This value is represented by the grey shaded rectangle.Total Revenue

ElasticityPriceQuantity Demanded (000s)DIf the firm decides to decrease price to (say) P3, the degree of price elasticity of the demand curve would determine the extent of the increase in demand and the change therefore in total revenue.P5100P3140Total Revenue

ElasticityPrice (P)Quantity Demanded10D556% Price = -50%% Quantity Demanded = +20%Ped = -0.4 (Inelastic)Total Revenue would fallProducer decides to lower price to attract salesNot a good move!

ElasticityPrice (P)Quantity DemandedD10520Producer decides to reduce price to increase sales7% in Price = - 30%% in Demand = + 300%Ped = - 10 (Elastic)Total Revenue risesGood Move!

The Total Revenue Test for ElasticityINELASTIC DEMANDELASTIC DEMANDDecrease in PriceELASTIC DEMANDINELASTIC DEMANDIncrease in PriceDecrease in Total RevenueIncrease in Total Revenue

Elasticities, Price Changes and Total Revenue

Spending and ElasticityIf demand is inelastic, buyers spend more on the good when its price is higher.If demand is elastic, buyers spend less on the good when its price is higher.If demand is unit-elastic, buyers spend the same amount on the good when its price is higher.

Determinants of ElasticityTime period the longer the time under consideration the more elastic a good is likely to be

Number and closeness of substitutes the greater the number of substitutes the more elastic

The proportion of income taken up by the product the smaller the proportion the more inelastic

Luxury or Necessity - for example, addictive drugs

Factors Affecting Elasticity of DemandAvailability of SubstitutesDemand for a good is more elastic when close substitutes for it are available to buyers.

Factors Affecting Elasticity of DemandFraction of Income Spent on the GoodAs people spend higher fractions of their incomes on a good, their demand for the good becomes more elastic.As they spend smaller fractions of their income on a good, their demand for it becomes less elastic.

Factors Affecting Elasticity of DemandAdjustment TimeDemand is more elastic when people have more time available to adjust to a change in price.

Determinants of Price Elasticity of DemandDemand tends to be more inelasticIf the good is a necessity.If the time period is shorter.The smaller the number of close substitutes.The more broadly defined the market.

Determinants of Price Elasticity of DemandDemand tends to be more elastic : if the good is a luxury.the longer the time period.the larger the number of close substitutes.the more narrowly defined the market.

What is likely to happen to the demand for these products when incomes rise by 15%?

Income ElasticityYED measures the responsiveness of quantity demanded to a change in income.it is the mathematical relationship between Y & QdYED = %Qd % YIf a change in income significantly alters the Qd, then YED is said to be relatively elastic.If a change in income does not have much affect on Qd, then YED is said to be relatively inelastic.

Elasticity YEDIncome Elasticity of Demand (YED):The responsiveness of demand to changes in incomesNormal Good demand rises as income rises and vice versaInferior Good demand falls as income rises and vice versa

YQYED Tells us about the type of good: for all normal goods, YED will be positive (as we earn more, we buy more)for inferior goods, YED will be negative (as we earn more, we buy less)Income Elasticity Normal goodInferior good

YQDY0Y1Q0Q1Income Inelastic Demand a large income change results in only a small change in Qd 0

YQDY0Y1Q0Q1Income Elastic Demand a small income change results in a large change in Qd 1 < YED found on optional products (a little boost in income suddenly adds these items to our basket)Income Elastic Demand

Income Elasticity Types of Goods

ElasticityPositive / NegativeNormal, NecessityInelasticPositiveInferior, NecessityInelasticNegativeNormal, OptionalElasticPositiveInferior, OptionalElasticNegative

Engels LawAs income rises, the proportion of income spent on food falls, even if actual expenditure on food rises. In other words, the income elasticity of demand of food is between 0 and 1. Thelawwas named after the statistician Ernst Engel (18211896).

Elasticity YED Income Elasticity of Demand:A positive sign denotes a normal goodA negative sign denotes an inferior good

Elasticity YED For example:

Yed = - 0.6: Good is an inferior good but inelastic a rise in income of 3% would lead to demand falling by 1.8%WHY? Use your YED formula and plug it in:(x/0.03)=-0.6(-0.6)(0.03)=x-0.018=x, or -1.8%Yed = + 0.4: Good is a normal good but inelastic a rise in incomes of 3% would lead to demand rising by 1.2%

Yed = + 1.6: Good is a normal good and elastic a rise in incomes of 3% would lead to demand rising by 4.8%

Yed = - 2.1: Good is an inferior good and elastic a rise in incomes of 3% would lead to a fall in demand of 6.3%

Income Elasticity of DemandNegative income elasticity of demand(ey

Income Elasticity of DemandIf Ey >1, demand is considered to be income elastic.If Ey

ElasticityPrice Elasticity of Supply:The responsiveness of supply to changes in priceIf PES is inelastic - it will be difficult for suppliers to react swiftly to changes in priceIf PES is elastic supply can react quickly to changes in pricePES = % Quantity Supplied____________________% Price

Price Elasticity of SupplyMeasures the responsiveness of quantity supplied to changes in price.Defined as the percentage change in quantity supplied of a good divided by the percentage change in the price of the good.Supply can be classified as elastic, inelastic, unit elastic, perfectly elastic, or perfectly inelastic.

PES: determinantslength of time

PRICE ELASTICITY OF SUPPLYWhat Is the Price Elasticity of Supply?

The price elasticity of supply is the ratio of the percent change in the quantity supplied to the percent change in price.The price elasticity of supply is interpreted in the same way as the price elasticity of demand.

PRICE ELASTICITY OF SUPPLYWhat Causes the Supply of Some Goods To Be More Elastic or More Inelastic than Others?

Substitution effectsTime: Same effect as elasticity of demand

PRICE ELASTICITY OF SUPPLYSubstitution effectsIf it is easy for sellers to switch production and sales to another good, if they have good alternative uses for their productive inputs, then, ceteris paribus, the supply of the good tends to be more elastic or less inelastic.

More or better substitutes Higher elasticity

If it is harder for sellers to switch to production and sales of alternative goods, if inputs tend to be more specialized, then, ceteris paribus, the supply of the good tends to be more inelastic or less elastic.

Few or poorer substitutes Lower elasticity

Price Elasticity of Supply

Price Elasticity of Supply and TimeThe longer the period of adjustment to a change in price, the higher the price elasticity of supply.Additional production takes time.Reducing production takes time.

Importance in Economic Theory and Practice

analyses the price-demand relationship. Pricing policy of the producer is greatly influenced by the nature of demand for his product.

Elasticity is a general measure of responsiveness that can be used to answer various questions.The price elasticity of demand the percent change in the quantity demanded divided by the percent change in the price (dropping the minus sign) is a measure of the responsiveness of the quantity demanded to changes in the price.Summary

The responsiveness of the quantity demanded to price can range from perfectly inelastic demand, where the quantity demanded is unaffected by the price, to perfectly elastic demand, where there is a unique price at which consumers will buy as much or as little as they are offered. When demand is perfectly inelastic, the demand curve is vertical; when it is perfectly elastic, the demand curve is horizontal.The price elasticity of demand is classified according to whether it is more or less than 1. If it is greater than 1, demand is elastic; if it is exactly 1, demand is unit-elastic; if it is less than 1, demand is inelastic. This classification determines how total revenue, the total value of sales, changes when the price changes. Summary

The price elasticity of demand depends on whether there are close substitutes for the good, whether the good is a necessity or a luxury, the share of income spent on the good, and the length of time that has elapsed since the price change.The income elasticity of demand is the percent change in the quantity of a good demanded when a consumers income changes divided by the percent change in income. If the income elasticity is greater than 1, a good is income elastic; if it is positive and less than 1, the good is income-inelastic.

Summary

The price elasticity of supply is the percent change in the quantity of a good supplied divided by the percent change in the price. If the quantity supplied does not change at all, we have an instance of perfectly inelastic supply; the supply curve is a vertical line. If the quantity supplied is zero below some price but infinite above that price, we have an instance of perfectly elastic supply; the supply curve is a horizontal line.The price elasticity of supply depends on the availability of resources to expand production and on time. It is higher when inputs are available at relatively low cost and the longer the time elapsed since the price change.

Summary

KEEP IN MIND Income elasticity measures shifts in the demand curvePrice elasticity measures movements along the curve

Summary of the Four Elasticity Concepts

END OF PRESENTATION

A pleasant good morning to everyone and Thank you for coming to class today to learn about Price Elasticity and Income Elasticity. These will be topics that Im going to present today. Since I dont a group mate or a partner on the topics assigned, I will be reporting both of the topics which I hope will not make you bored. Being a BS Food Tech graduate, I will be reporting the topic using simple and basic concepts as I know not all of us here are Economic Majors. Im excited to present since knowing the concepts allowed me to look at the application since I worked in food manufacturing company. Later, Well try to cite practical applications in order to relate what we will be discussing on our day-to-day activities and since we are enrolled in this course, Managerial Economics, we see the importance / implications of elasticity in making managerial decisions.

*The learner will understand the importance of the concept of price and income elasticity to the demand for goods and services.

*Every day we buy many things from clothing toys to electronics to things we really need like food or healthcare but before buying anything, you may have ask your self is really worth the price? If you think so, you will buy it, if not, you will pass, but if you really need it youll pay anything, if you have this thoughts you might be thinking like an economist?Prior explaining each topic, we define terms based on the context of the discussion.

*We have studied a host of demand determinants and how supply and demand curves act together to determine market equilibrium, and how shifts in these two curves are reflected in prices and quantities consumed and how. The change in these demand determinants brings about a change in the market demand for goods and services. Not all curves are the same, however, and the steepness or flatness of a curve can greatly alter the affect of a shift on equilibrium.

*is a measure of how much buyers and sellers respond to changes in market conditions allows us to analyze supply and demand with greater precisionA general concept used to quantify the response in one variable when another variable changes.

*Response in other terms is also called reaction.Measures responsiveness or sensitivity of consumers to changes in the price of a goodThe law of demand tells us that as the price of a good increases the quantity that will be bought decreases but does not tell us by how much.ep [ownprice elasticity] is a measure of that information] If you change price by 5%, by what percent will the quantity purchased change?

*Alfred Marshall(26 July 1842 13 July 1924) was one of the most influential economists of his time. His book,Principles of Economics(1890), was the dominant economic textbook in England for many years.**Insert mid point formulaThe midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change.

**Because elasticity is a ratio of two percentages, the percentages cancel out so that elasticity is a pure number, a number with no units of measurement attached to it. Allows us to compare the demands for different goods even though they are measured in different units or to compare goods at different points in time or even to compare goods in different countries that use different currencies.

*The concept of price elasticity reveals that the degree of responsiveness of demand to the change in price differs from commodity to commodity. Demand for some commodities is more elastic while that for certain others is less elastic. Using the formula of elasticity, it possible to mention following different types of price elasticity:

**87Perfectly Inelastic Demand (Ed = 0) If quantity demanded is completely unresponsive to changes in price, demand is perfectly inelastic. A change in price causes no change in quantity demanded.Demand is perfectly inelastic.

The percentage change in quantity demanded is zero when the price changes.

Consumers are completely insensitive or unresponsive to the price change. They want the same quantity no matter what the price is.

A perfectly inelastic demand curve is vertical.Another example would be insulin to a diabetic.

*87Inelastic Demand (Ed < 1): the numerator is less than the denominator , the coefficient is less than 1, and demand is inelastic.Demand is inelastic.

The percent change in quantity demanded is smaller than the percent change in price

Consumers are relatively insensitive or not very responsive to price changes.

*87Unit Elastic Demand (Ed = 1): If the numerator and denominator are the same, the coefficient is equal to one. The quantity demanded changes proportionally to a change in price.Demand is unit elastic.

The percent change in quantity demanded equals the percent change in price

Consumers are neither very sensitive or responsive to price changes nor are they very insensitive or unresponsive.

*87Elastic Demand (Ed > 1): the numerator is greater than the denominator, the coefficient is greater than 1 and demand is elastic.Demand is elastic.

The percent change in quantity demanded is greater than the percent change in price

Consumers are relatively sensitive or responsive to price changes.Apple iPhones, iPads. The Apple brand is so strong that many consumers will pay a premium for apple products. If the price rises for apple iPhone, many will continue to buy. If it was a less well known brand like Dell computers, you would expect demand to be price elastic.Gasolie

*87Perfectly Elastic Demand (Ed = ) If the quantity demanded is extremely responsive to a change in price.Demand is perfectly elastic.Even an infinitesimally small percentage price change will cause a very (infinitely) large percentage change in quantity demanded.The numerator (the percent change in quantity demanded) is so large and the denominator (the percent change in price) is so small that the coefficient of elasticity approaches infinity in the limit.The demand curve is horizontal are almost so.

**2115**Necessities versus LuxuriesAvailability of Close SubstitutesDefinition of the MarketTime Horizon

**Substitution effects: Examples

Ceteris paribus, the demand for Toyota Camrys is likely to be more elastic (or less inelastic) than the demand for automobiles which in turn is more elastic (or less inelastic) than the demand for motor vehicles.

The demand for a college textbook is likely to be more inelastic (or less elastic), ceteris paribus, than the demand for a popular novel.

*Purchases of automobiles require a larger proportion of income than purchases of gasoline so, ceteris paribus, the demand for automobiles is likely to be more elastic (or less inelastic) than the demand for gasoline.

Households spend more of their income on steak than on the salt to put on the steak. Ceteris paribus, the demand salt is likely to be more inelastic (or less elastic) than the demand for steak.Income Effects

If consumers spend a relatively larger percent of their income on a good, then, ceteris paribus, the demand for the good tends to be more elastic or less inelastic.

Larger share of income Higher elasticity

If consumers spend a relatively smaller percent of their income on a good, then, ceteris paribus, the demand for the good tends to be less elastic or more inelastic.

Smaller share of income Lower elasticity

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The longer the time period over which elasticity is measured, the larger, ceteris paribus, it is likely to be because consumers have more time to find good substitutes and adjust their consumption.

Longer time Higher elasticity

Shorter time Lower elasticity

**138Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers income. It is computed as the percentage change in the quantity demanded divided by the percentage change in income.

*Normal GoodsIncome Elasticity is positive.Inferior GoodsIncome Elasticity is negative.Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods. Normal goodshave apositive income elasticity of demandso as consumers' income rises more is demanded at each price i.e. there is an outward shift of the demand curveInferior goodshave anegative income elasticity of demandmeaning that demand falls as income rises. Typically inferior goods or services exist wheresuperior goods are availableif the consumer has the money to be able to buy it. Examples include the demand for cigarettes, low-priced own label foods in supermarkets and the demand for council-owned properties.

*Many necessities have an income elasticity of demand between zero and one: expenditure on these goods may increase with income, but not as fast as income does, so the proportion of expenditure on these goods falls as income rises. This observation for food is known as Engel's law.

**This slide has a ten second gap in between each example to allow the teacher to explain how the figures have been calculated. This gap can be increased or reduced as appropriate using the custom animation tool. Income Elasticity of Demand Greater than One: When the percentage change in demand is greater than the percentage change in income, a greater portion of income is being spent on a commodity with an increase in income- income elasticity is said to be greater than one.Income Elasticity is unitary: When the proportion of income spent on a commodity remains the same or when the percentage change in income is equal to the percentage change in demand, EY = 1 or the income elasticity is unitary.Income Elasticity Less Than One (EY< 1): This occurs when the percentage change in demand is less than the percentage change in income.Zero Income Elasticity of Demand (EY=o): This is the case when change in income of the consumer does not bring about any change in the demand for a commodity.Negative Income Elasticity of Demand (EY< o): It is well known that income effect for most of the commodities is positive. But in case of inferior goods, the income effect beyond a certain level of income becomes negative. This implies that as the income increases the consumer, instead of buying more of a commodity, buys less and switches on to a superior commodity. The income elasticity of demand in such cases will be negative.

*In nutshell, it can be concluded that the concept of elasticity of demand has great significance in economic analysis. Its usefulness in branches of economic such as production, distribution, public finance, international trade etc., has been widely accepted.

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