ELASTICITY OF DEMAND

ScenarioPriceQuantity demanded A92 B84 C5.59 D4.511 E216 F118 We start with a hypothetical demand schedule From the left-side Table we observe that from A to B, Change of price is -1, and change of quantity demanded is 2. Similarly from C to D, Change of price is -1, and change of quantity demanded is 2. and from E to F, Change of price is -1, and change of quantity demanded is 2. So, our hypothetical demand curve will be linear similar to left one. A B C D E F Quantity demanded P

Calculation of Elasticity Elasticity between the point A and B = There are two issues to calculate percentage change. Issues are (1) which one be Base price ? And (2) Which one be Base quantity ?

ScenarioPriceQuantity demanded A92 B84 C5.59 D4.511 E216 F118 Calculation of Elasticity on a linear demand curve:- A to B In our calculation we didn’t address the issue (problem). Our Base price and quantity are initial price and quantity. In order to address the issue we can calculate elasticity taking average of initial value and next value.

Calculation of elasticity taking average of initial value and next value:- ScenarioPriceQuantity demanded A92 B84 C5.59 D4.511 E216 F118 Practice calculating elasticity between C and D; E and F points

A B C D E F Elasticity is greater than 1 Elasticity is less than 1 Elasticity is equal to 1 Elasticity along a linear demand curve An important point is when unit of change between two points are same but % change is different. Why ? The answer is – because of initial value. the percentage change in price becomes smaller when the initial value is larger.

1)a price increase from $1 to $2 represents a 100% increase in price, 2) a price increase from $2 to $3 represents a 50% increase in price, 3) a price increase from $3 to $4 represents a 33% increase in price, and 4) a price increase from $10 to $11 represents a 10% increase in price. Notice that, even though the price increases by $1 in each case, the percentage change in price becomes smaller when the initial value is larger. Examples:-

 Demand is said to be:  elastic when Ed > 1,  unit elastic when Ed = 1, and  inelastic when Ed < 1. ELASTICITY IN DIAGRAM:- (a) Elastic demand (b) Unit-elastic demand © Inelastic demand Elasticity range from 0 to infinity Q Q Q P D P D P D D D D 10% more than 10% 10% equal to10%10% less than 10%

The price drops by 1 percent, causing the quantity demanded increase by 2 percent, so demand is therefore what ? Elastic or inelastic, is it greater than one, equal to one, or less than one. ? What would happen if quantity demanded increase by half percent instead of 2 percent ? Quiz

What are the determinants of price elasticity of demand ? Rice Coffee Tea Shoe BMW car Salt

Is it essential for livelihood ? Major share of budget is spent for what ? Do the commodities have close substitution ? What are the determinants of price elasticity of demand. Essential goods like rice, salt have inelastic demand curve mean quantity demanded is less responsive to change of price of the goods. On the otherhand luxury goods has high responsive demand curve. 0 Quantity High responsive demand curve i.e. elastic Less responsive demand curve i.e. inelastic

DP Quantity 0 Highly inelastic because very essential and no substitution. These commodities are not essential for life; moreover, tea and coffee are close substitute for each other. So, their demand curve should be elastic D D D

ScenarioPriceQuantity demanded Total Revenue A9218 B8432 C D E21632 F118 Quantity demanded TR Total Revenue and Elasticity TR = Price * Quantity Ed < 1

Total Revenue and Elasticity TR up TR down Ed < 1 Ed > 1 Ed = 1