The Concepts of Demand and Elasticity

Assistant Professor Chanin YoopetchAssistant Professor Chanin Yoopetch

Learning outcomes

By studying the end of this section students will be able to: evaluate the work/leisure trade-off evaluate the notion of a “leisure society” understand and apply the concept of price elasticity of

demand understand and apply the concept of income elasticity of

demand understand and apply the concept of cross price elasticity of

demand describe simple methods of demand forecasting evaluate techniques of demand forecasting

The demand for leisure Two potential effects of an increase in

income on the demand for leisure time The substitution effect: First, an increase in income

means an increase in the opportunity cost of leisure time. In this case we may expect consumers to demand less leisure time.

The income effect: Leisure time can be classed as a ‘normal service’, and in common with other ‘normal’ goods and services, as income increases more will be demanded.

Elasticity . . .

… is a measure of how much buyers and

sellers respond to changes in market

conditions. . .

… allows us to analyze supply and demand

with greater precision.

Elasticity: A General Definition:

The percentage (%) change in

something . . .

. . . given a one percent (1%) change in

something else.

Three Types of Elasticities. . .

Price Elasticity of Demand

Income Elasticity Price Elasticity of Supply

Price

Quantity

Price Elasticity of Demand

The percentage change in the quantity demanded

given. . .

. . . a one percent change in the price.

A

B

DemandP

Q

Ranges of Elasticity . . .

Perfectly Inelastic Consumers are “extremely

unresponsive” to price changes.

Perfectly Elastic Consumers are “extremely

responsive” to price changes.

Unit Elastic Response is “equal to” change in price.

Elasticity of Demand Illustrated

Perfectly Inelastic

Perfectly Elastic

Elasticity of Demand Illustrated

Perfectly Inelastic

4

5

Q

Elasticity of Demand Illustrated

Perfectly Elastic

4 Q

At any price above 4, quantity demanded = 0

At any price under 4, quantity demanded = infinity

Determinants of Price Elasticity of Demand

Demand tends to be more elastic: if the good is a luxury; the longer the time period; the greater the number of close

substitutes; and the more narrowly defined the

market.

Determinants of Price Elasticity of Demand

Demand tends to be more inelastic: if the good is a necessity; the shorter the adjustment time; if there are few good substitutes; and the more broadly defined the market.

Computing Elasticity Coefficient

Computed as the percentage change in the quantity demanded divided by the percentage change in price.

Price Elasticityof Demand

=

Percentage Change in Quantity Demanded

Percentage Change in Price

Computing Elasticity Coefficient

Demand forIce Cream

2.20

2.00

108

ED

($2.20 - $2.00) / $2.00

(8 - 10) / 10

=

Computing Elasticity Coefficient

Demand forIce Cream

2.20

2.00

108

ED

(10%)

(20%)

=

Computing Elasticity Coefficient

Demand forIce Cream

2.20

2.00

108

ED= 2

Computing Elasticity Coefficient

Demand forIce Cream

2.20

2.00

108

ED= 2

Demand is Elastic

> 1

Price changes a little, but quantity changes a lot.

Demand for Ice Cream

2.20

2.00

108

What if the price declines in different direction? What is Price Elasticity of Demand?

Income Elasticity... Types

Goods consumers regard as “necessities” tend to be income inelastic...Examples include: food, fuel,

clothing, utilities, & medical services.

Price elasticity of demand Example

Price elasticity of demand Practice

1. The price of air ticket from Bangkok to Tokyo rose from 20,000 to 28,000 Baht and demand falls from 4,500 – 3,800 tickets sold per week. Calculate elasticity of demand

2. The price of air ticket from Bangkok to Seoul rose from 20,000 to 28,000 Baht and demand falls from 3,800 to 3,700 tickets sold per week. Calculate elasticity of demand

Which one has higher elasticity of demand?

Price elasticity of demand Factors affecting price elasticity of demand

necessity of good or service number of substitutes addictiveness price and usefulness time period consumer awareness

Elasticity of demand and total revenue

Elasticity and Total Revenue(TR)

Over the Elastic Range of

prices and quantity the relationship between price and total

revenue is

INDIRECT or OPPOSITE

Elasticity and Total Revenue

ED > 1 then

P Q TRand

Elasticity and Total Revenue

Over the Inelastic Range of prices and quantity

the relationship between price and total revenue is

DIRECT or THE SAME

Elasticity and Total Revenue

ED < 1 then

P Q TRand

Income Elasticity of Demand

The percentage change in the quantity demanded

given a one percent change in income.

Computing Income Elasticity

Computed as the percentage change in the quantity demanded divided by the percentage change in Income.

Income Elasticityof Demand

=

Percentage Change in Quantity Demanded

Percentage Change in Income

Income Elasticity of Demand... Types

YD > 0 Normal Goods(Clothes)

YD < 0 Inferior Goods(Bus rides)

YD = 0 Income-neutral

Goods(Medicines)

Income Elasticity... Types

Goods consumers regard as “luxuries” tend to be income elastic...Examples include: Sports cars,

furs, and expensive foods.

Cross-price elasticity of demand Definition

Percentage change in quantity demanded of good A ÷ Percentage change in price of good B

This is to see when price of B changes, how price of good A will change.

Cross-price elasticity of demand measures the relationship between different goods and services. It therefore reveals whether goods are Substitutes

Having positive cross-price elasticity (+/+ =+) Complements

Negative cross-price elasticity (-/+ = -) unrelated.

Cross-price elasticity is zero (0/+= 0)

Demand forecasting Methods for forecasting demand (Frechtling,

2001) include: naive forecasting

Making simple assumptions about the future (assume the 3% increase for demand)

qualitative forecasts ‘Ranking’ the importance of factors affecting future trends

(no mathematic models) time-series extrapolation

Using a series of data (e.g. monthly data of international visitors

from 1990-2009 to forecast the future arrivals of tourists in the next five years.)

Demand forecasting Methods for forecasting demand (Frechtling,

2001) include: Surveys

Where no time series data exist. Surveys can be used by acquiring data from respondents to forecast demand.

Delphi technique Using expert opinion to forecast with the aim of reaching a

consensus among the experts Models

Complex methods involving statistical or econometric techniques to construct a comprehensive model with economic variables, such as interest rates, inflation rates, and growth rates.