The Concepts of Demand and Elasticity Assistant 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 Demand P 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 Elasticity of Demand = Percentage Change in Quantity Demanded Percentage Change in Price

Computing Elasticity Coefficient Demand for Ice Cream EDED ($ $2.00) / $2.00 (8 - 10) / 10 =

Computing Elasticity Coefficient Demand for Ice Cream EDED (10%) (20%) =

Computing Elasticity Coefficient Demand for Ice Cream EDED = 2

Computing Elasticity Coefficient Demand for Ice Cream EDED = 2 Demand is Elastic > 1 Price changes a little, but quantity changes a lot.

Demand for Ice Cream 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 E D > 1 then P QTR and

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 E D < 1 then P QTR and

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 Elasticity of Demand = Percentage Change in Quantity Demanded Percentage Change in Income

Income Elasticity of Demand... Types Y D > 0 Normal Goods(Clothes) Y D < 0 Inferior Goods(Bus rides) Y D = 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 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.