Chapter 4 Demand Elasticity Managerial Economics: Economic Tools for Today’s Decision Makers, 4/e By Paul Keat and Philip Young Lecturer: KEM REAT Viseth,

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Presentation transcript:

Chapter 4 Demand Elasticity Managerial Economics: Economic Tools for Today’s Decision Makers, 4/e By Paul Keat and Philip Young Lecturer: KEM REAT Viseth, PhD (Economics)1

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 2 Demand Elasticity The Economic Concept of Elasticity The Price Elasticity of Demand The Cross-Elasticity of Demand Income Elasticity Other Elasticity Measures Elasticity of Supply

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 3 The Economic Concept of Elasticity Elasticity: The sensitivity of one variable to another or, more precisely, the percentage change in one variable relative to a percentage change in another.

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 4 The Price Elasticity of Demand Price elasticity of demand: The percentage change in quantity demanded caused by a 1 percent change in price.

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 5 The Price Elasticity of Demand Arc elasticity: Elasticity which is measured over a discrete interval of a demand (or a supply) curve.

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 6 The Price Elasticity of Demand Point elasticity: Elasticity measured at a given point of a demand (or a supply) curve.

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 7 The Price Elasticity of Demand The point elasticity of a linear demand function can be expressed as:

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 8 The Price Elasticity of Demand Elasticity differs along a linear demand curve.

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 9 The Price Elasticity of Demand Categories of Elasticity 1.Relative elasticity of demand E P > 1 2.Relative inelasticity of demand E P < 1 3.Unitary elasticity of demand E P = 1

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 10 The Price Elasticity of Demand Limiting cases 1.Perfect elasticity E P = ∞ 2.Perfect inelasticity E P = 0

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 11 The Price Elasticity of Demand Determinants of Elasticity Ease of substitution Proportion of total expenditures Durability of product Possibility of postponing purchase Possibility of repair Used product market Length of time period

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 12 The Price Elasticity of Demand A long-run demand curve will be more elastic than a short-run curve. As the time period lengthens consumers find way to adjust to the price change

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 13 The Price Elasticity of Demand Derived demand: The demand for products or factors that are not directly consumed, but go into the production of a final product. The demand for such a product or factor exists because there is demand for the final product.

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 14 The Price Elasticity of Demand 1.the more essential is the component in question. 2.the more inelastic is the demand curve for the final product. 3.the smaller is the fraction of total cost going to this component. 4.the more inelastic is the supply curve of cooperating factors. The derived demand curve will be more inelastic:

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 15 The Price Elasticity of Demand There is a relationship between the price elasticity of demand and revenue received. If price decreases and, in percentage terms, quantity rises more than price dropped, then total revenue will increase. If price decreases and, in percentage terms, quantity rises less than price dropped, then total revenue will decrease.

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 16 The Price Elasticity of Demand As price decreases revenue rises when demand is elastic falls when it is inelastic reaches it peak when elasticity of demand equals 1.

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 17 The Price Elasticity of Demand Marginal Revenue: The change in total revenue resulting from changing quantity by one unit.

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 18 The Price Elasticity of Demand For a straight-line demand curve the marginal revenue curve is twice as steep as the demand.

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 19 The Price Elasticity of Demand At the point where marginal revenue crosses the X-axis, the demand curve is unitary elastic and total revenue reaches a maximum.

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 20 The Cross-Elasticity of Demand Cross-elasticity of demand: The percentage change in quantity consumed of one product as a result of a 1 percent change in the price of a related product.

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 21 The Cross-Elasticity of Demand Arc Elasticity

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 22 The Cross-Elasticity of Demand Point Elasticity

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 23 The Cross-Elasticity of Demand The sign of cross-elasticity for substitutes is positive. The sign of cross-elasticity for complements is negative.

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 24 Income Elasticity Income Elasticity of Demand: The percentage change in quantity demanded caused by a 1 percent change in income.

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 25 Income Elasticity Arc Elasticity

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 26 Income Elasticity Point Elasticity

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 27 Income Elasticity Categories of income elasticity Superior goods E Y > 1 Normal goods 0 > E Y > 1 Inferior goods E Y < 1

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 28 Income Elasticity Categories of Income Elasticity Superior goods Normal goods Inferior goods

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 29 Other Elasticity Measures Elasticity is encountered every time a change in some variable affects quantities. Advertising expenditure Interest rates Population size

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 30 Elasticity of Supply Price Elasticity of Supply: The percentage change in quantity supplied as a result of a 1 percent change in price

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 31 Elasticity of Supply Arc elasticity

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 32 Elasticity of Supply Point elasticity

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 33 Elasticity of Supply If the supply curve slopes upward and to the right, the coefficient of supply elasticity is a positive number.

Lecturer: KEM REAT Viseth, PhD (Economics) Managerial Economics, 4/e Keat/Young 34 Elasticity of Supply When the supply curve is more elastic, the effect of a change in demand will be greater on quantity than on the price of the product. With a supply curve of low elasticity, a change in demand will have a greater effect on price than on quantity.