Elasticity of demand

 What elasticity measures?  How the price elasticity formula is applied to measure the elasticity of demand?  The difference between elastic, inelastic and unitary elastic demand?  How total revenue varies in each of these tree cases?  The meaning of perfect elasticity and perfect inellasticity

Price elasticity of demand  is a measure of the sensitivity of quantity demanded to chages in the price of a product  When quantity demanded is relatively sensitive (insensitive) to a price change demand is said to be elastic (inelastic)

Degree of elasticity The exact degree of elasticity can be measured by using a formula to compute the elasticity coefficient: where:   D – percentage change in demand: (y t -y t-1 )/y t-1   P – percentage change in prices: (x t -x t-1 )/x t-1

How to estimate price elasticity P - priceD - demand∆P∆DEp 2, %-25%-0,25 7,54050%-33%-0, %-50%-1,50 It is important to note that the elasticity of demand is not the same at all prices and that demand is typically elastic at higher and inelastic at lower prices

Elastic, inelastic and unit elastic demand Demand is elastic ( inelastic, unit elastic ) when the percentage change in quantity is greater then (less then, equal to) the percentage change in price and the elasticity coefficient is greater than (less than, equal to) 1

The sign of elasticity coeficient Because price and quantity demanded are inversely related to each other the price elasticity of demand coefficient is a negative number – but economists ignore the minus sign in front of the coefficient and focus their attention on its absolute value

The price elasticity of demand for a product depends upon  the number of good subsitutes the product has  its relative importance in the consumer’s budget  whether it is a necessity or luxury

Relation between price elasticity and revenue The way in which total revenue changes (increases, decreases, or remains constant) when price changes is a test of the elasticity of demand for a product  For elastic demand E p (- ∞ ;-1): when price decreases (increases) then revenues increases (decreases)  For inelastic demand E p (- 1 ; 0): when price decreases (increases) then revenues decreases (increases)  For unit elastic demand E p =-1: the revenues are maximum

The example of the previous rule P – price in £ D-demand in tho.of units ∆P∆DEpEp Revenues in tho. of £ 2, %25%-0, , %7%-0, ,5056-9%7%-0, ,0052-4%4%-0, , %12%-1,00312,5 7,0044-7%9%-1, , %50%-1, ,0020

Fill-in questions 1  To find out that the demand is elastic you must know (price elasticity of demand, income elasticity of demand)……………...

Fill-in questions 2  If a relatively large change in price results in a relatively small change in demand, demand is (elastic/ineclastic/perfect eleasit)…………………………….  If a relatively small change in price results in a relatively large change in demand, demand is (elastic/ineclastic/perfect eleastic)…………………………..

Fill-in questions 3  If a change in price causes no change in demand, demand is perfectly (elastic, inelastic)…………………...and the demand curve is (perpendicular to any axis, slopes down in the rights)…………………  If an extremely small change in price results in an extremely large change in demand, demand is (perfectly elastic/perfectly inelastic)

Fill-in questions 4 If the price of a commodity declines  when demand is inelastic the loss of revenue due to the lower price is (greater than, less then, equal to) …………………….the gain in revenue due to the greater quantity demanded  when demand is elastic the loss of revenue due to the lower price is (greater than, less then, equal to) …………………….the gain in revenue due to the greater quantity demanded  when demand is inelastic the loss of revenue due to the lower price is (greater than, less then, equal to) …………………….the gain in revenue due to the greater quantity demanded

Fill-in questions 5  If demand is elastic, price and total revenue are (directly, inversely) …….…… related  If demand is inelastic, price and total revenue are (directly, inversely) …….…… related

Fill-in questions 6 Complete the summary table below If demand is: The elasticity coefficient is If price rises, total revenue will If price falls, total revenue will Elastic Inelastic Of unitary elasticity

Fill-in questions 6 Which of below determinants are not the determinants of the elasticity of demand: 1. The number of good substitute products 2. The relative importance of the product in the total budged of the buyer 3. Whether the good is a necessity or a luxury

Fill-in questions 7 If the demand schedules for a certain product are those given in the table, answer the following questions. Price in $Demand in units What is price elasticity of demand for price P=6$ If we reduct price to 5$, revenus will (decrease/increase)……… What is the „best” price for this product……………………………..