Elasticity

1

Prepared by; RASHAIN PERERA077 059 37 52rashainperera@gmail.com

What is elasticity?

Elasticity is the responsiveness of the dependent variable to the changes of the independent variable.

Elasticity simply refers to; Responsiveness Response

3

Methods of measuring elasticity Percentage method Point method Arc method

4

Point method

This measures the elasticity at a specific point on the curve

Weaknesses of using point method are; Coefficient takes 2 different values for the

same given change in quantity demand and price though slope is constant at every place.

Due to this weakness this method is not used in practice to make economic decisions

Arc elasticity is used to avoid this problem.5

Arc method

This calculates the average responsiveness of quantity demand over some portion on the curve. (Along the curve)

6

Types of elasticities

Price elasticity Price elasticity of demand Price elasticity of supply

Cross price elasticity of demand Income elasticity of demand

7

Price elasticity of demand

Definition; Price elasticity of demand measures the responsiveness of quantity demand following a change in the price. In other words it is the percentage change in the quantity demanded of a product that results from 1% change in the price of the same product.

8

b=

x

x

9

Types of price elasticities of demand Perfectly elastic demand Elastic demand Unitary elastic demand Inelastic demand Perfectly inelastic demand

10

Perfectly elastic demand

Price Quantity demand100100

10002000

11

Price

Quantity

PED = α

Elastic demand

Price Quantity demand100110

1000500

12

Price

Quantity

PED = α - 1

Unitary elastic demandPrice Quantity demand124

1005025

13

Price

Quantity

PED = 1

Inelastic demand

Price Quantity demand100200

1000900

14

Price

Quantity

PED = 1 - 0

Perfectly inelastic demandPrice Quantity demand100200

10001000

15

Price

Quantity

PED = 0

Uses of price elasticity of demand To the government to take

practical decisions and to make economic policies, tax rates and tax revenue.

To analyze market situations Helps businessmen

16

Determinants of price elasticity of demand

substitutability More substitutes-elastic less substitutes-inelastic

definition of the good broadly defined-inelastic narrowly defined-elastic

habit forming or not habit forming-inelastic non-habit forming-elastic

income portion that is allocated on the product high income portion-elastic low income portion-inelastic

number of uses or benefits of the product more uses-inelastic less uses-elastic 17

Relationship between price elasticity of demand, producer revenue and consumer expenditure Consumer expenditure= price x quantity

bought Producer revenue= price x quantity sold

Therefore producer revenue = consumer expenditure

18

Effect on CE/PR

When price decrease

When price increase

Inelastic demand Decrease IncreaseElastic demand Increase Decrease Unitary elastic demand

No change No change

19

Price elasticity of supply

Definitions; Price elasticity of supply measures the responsiveness of quantity supplied that results in 1% change in price of the concerned product.

20

b=

x

x

21

Types of price elasticities of supply Perfectly elastic supply Elastic supply Unitary elastic supply Inelastic supply Perfectly inelastic supply

22

Perfectly elastic supplyPrice Quantity supplied100100

10002000

23

Price

Quantity

PES = α

Elastic supplyPrice Quantity supplied100110

10002000

24

Price

Quantity

PES = α - 1

Unitary elastic supplyPrice Quantity supplied102030

100200300

25

Price

Quantity

PES = 1

Inelastic supplyPrice Quantity supplied100200

10001100

26

Price

Quantity

PES = 1 - 0

Perfectly inelastic supplyPrice Quantity supplied100200

10001000

27

Price

Quantity

PES = 0

Determinants of elasticity of supply; Perishability

High –elastic Low -inelastic

Time taken for production High –inelastic Low -elastic

Factor mobility High –elastic Low -inelastic

Flexibility of the production process High –elastic Low -inelastic

Uses of the product More –inelastic Less -elastic 28

Cross price elasticity of demand Definitions; Cross price elasticity of

demand measures the responsiveness of quantity demand following a change in the price of other products. Normally we measure this only for demand

29

C b=

Cx

Cx

30

CED

POSITIVE-SUB

CED>1 CLOSE SUB

CED<1 REMOTE SUB

NEGATIVE-COM

ZERO-NON RELATED

31

Uses of cross price elasticity of demand To identify the inter relationship

between the products For the preparation of economic

policies To determine the degree of

monopoly powers

32

Income elasticity of demand Definitions; YED measures the

responsiveness of the quantity demand of a product following a change in the income of people.

33

Y b=

Yx

Yx

34

YED

POSITIVE-NORMAL

YED>1 LUXURY

YED<1 ESSENTIAL

NEGATIVE-INFERIOR

35