ELASTICITY OF DEMAND  PRICE ELASTICITY OF DEMAND  CROSS ELASTICITY OF DEMAND  INCOME ELASTICITY OF DEMAND

Price elasticity of Demand  Price increases always cause a decrease in quantity demanded (law of demand).  BUT  For different products, the degree of responsiveness varies from elastic (very responsive) to inelastic (not very responsive).  This responsiveness can be measured in a number of ways Measures responsiveness of changes in quantity demanded to changes in price.

Total revenue method p pp q q q AB C Consider products A, B and C. Price rises by the same amount for each. Quantity demand falls for each - but by a different amount. In A, total revenue (P*Q) has increased after the price rise. In B, TR has remained the same and in C, TR has fallen. d d d A is inelastic B is unitary C is elastic

TOTAL REVENUE METHOD  IF PRICE AND TOTAL REVENUE MOVE IN THE SAME DIRECTION THEN  IF PRICE AND TOTAL REVENUE MOVE IN OPPOSITE DIRECTIONS THEN INELASTIC DEMAND ELASTIC DEMAND DemandPrice IncreasePrice Decrease ElasticTotal revenue will decrease Total revenue will increase InelasticTotal revenue will increase Total revenue will decrease

ELASTICITY COEFFICIENT Percentage Change Method  Ed = %Qd / %P  Use this method if you do not have both prices and both quantity demands. Mid Point Method  Ed = Qd Q1+Q2 P1+P2  P This method is more accurate. Use it if you have both quantities and both prices. X

ELASTICITY AT A POINT P P Q Q X Y Z X Y Z To calculate elasticity of demand at point X, measure the distance XY and divide by the distance XZ. If the demand function is a curve you need to draw a tangent line at the point on the curve.

Elastic and Inelastic Demand Curves Quantity Price($) Quantity Price($) Relatively Inelastic Relatively Elastic Shows that a change in price will result in a proportionately larger change in demand Shows that a change in price will result in a proportionately small change in demand

SPECIAL CASES P P Q Q D D PERFECTLY INELASTIC. A change in price brings about no response - no change in quantity demand. PERFECTLY ELASTIC A change in price brings about an infinite response in quantity demand. Ed=0 Ed= 

WHY INELASTIC?  A necessity - either real or reputed.  No close substitutes.  A small % of income spent on it.  Non-durable  Government regulation makes it a compulsory purchase.

WHY ELASTIC ?  Many substitutes  A luxury  A high % of income spent on it.  Durable

Workbooks page 19-20

CROSS ELASTICITY OF DEMAND  The sign of the coefficient (+ or -) is important.  Ecross = %Qa %Pb or  What would the equation be for the midpoint method? Measures the responsiveness of quantity demanded of one product to changes in the price of another.

Ecross Coefficient  If Ecross < -1 then it indicates that the two products are complements. The lower the number the stronger the complementary relationship.

Ecross Coefficient  If Ecross >1 it indicates that the two products are substitutes. The higher the number the closer the substitute relationship.

Income elasticity of demand  E= %Qd %Y  What would the equation be for the midpoint method? Measures the responsiveness of a change in quantity demanded to a change in income

INFERIOR GOODS  Income inelastic Qd Income E < 0

NORMAL GOODS Qd income E > 1 0 < E < 1 Income elastic Luxury goods Income inelastic Necessity

GIVE REASONS  This person needs new windscreen wipers before she gets her car registered. Comment on the price elasticity. Give 4 reasons.

EXPLAIN  As a persons income increases the % of their income that they spend on food falls.  True or false?  Explain why.

Vocabulary  Measures responsiveness of demand to changes in price of another good.  A good with negative income elasticity. Cross elasticity Inferior goods

Vocabulary  Measures responsiveness of quantitydemand to changes in price.  Measures responsiveness of quantity demand to changes in income Price elasticity Of demand Income elasticity Of demand