1. Elasticities and market adjustments
Lecture 4

2. The elasticity of demand and supply
Price elasticity of demand
Cross price elasticity of demand
Income elasticity of demand
Price elasticity of supply

3. Elasticity of demand depends on:
Buyers behavior norms (their preferences and customs)
The availiability of the substitutes to the good
Narrow or wide groups of goods
Short or long term

4. Price elasticity of demand (UK 1970s)
Wide groups of goods
Price elasticity
Narrow groups of goods
Fuels and energy
- 0.47
Milk and its products
-0.10
Food
-0.52
Bread
-0.22
Alkohol
-0.83
entertaiment
-1.40
Durable consumer goods,
-0.89
Trips abroad
-1.63
services
-1.02
restaurants
-2.61

5. Price elasticity of demand
The relation of a percentage change of demand to a percentage change of price
An example: price cut from 10 to 7.5, quantity demanded increases from 20 to 40
% change in quantity demanded =
(40 – 20)/20 x 100% = 100%
% change in price = (10-7.5)/10 x 100% = -25%
Price elasticity of demand = 100/-25= -4
Different price elasticities of demand along the demand curve
WHY?

6. Some features of price elasticity of demand
Usually with „-”, although there are some cases when it has „+”
High and low price elasticity, what does it mean?
Linear demand function – graphical downward slopped curve,
Along the whole linear demand curve decrease of price by 1 unit results in the increase of demand by the same quantity of units (absolute change of demand ∆D is constant.
But elasticity of demand being relation of relative changes, is different at different points of the curve.
It is high at high prices and low at low prices. (valid only for linear demand function)

7. Price elasticity of demand-how to calculate?
Price P
Demand Q
elasticity 10 1 9
-1/9 2 8
-1/4 3 7
-3/7 4 6
-2/3 5 -1
-3/2
-7/3 -4 -9 -∞

8. Elasticity of demand for tickets EURO 2012
PRICE OF THE TICKET (Euro)
Demand (thousands for 1 game)
Price Elasticity of demand
12.50 -∞
10.00 20
- 4.00
7.50 40
- 1.50
5.00 60
- 0.67
2.50 80
- 0.25
0.00
100

9. Extreme cases
Perfectly elastic demand function –horizontal line along which price elasticity of demand equals - ∞
Perfectly inelastic demand – vertical line along which price elasticity of demand equals 0 („I must have that, whatever the price”)
0<E < 1 – demand inelastic, E >1 – demand elastic

10. How useful is information on price elasticity of demand? (1)
Allows to calculate: 1. how much to increase the price to eliminate demand surplus; 2. how much to decrease the price to eliminate supply surplus
Years of a bad and good harvest, demand for corn relatively inelastic
A bad harvest – prices go up but the weak reaction of demand – income of farmers is growing
High production of corn – price going down – weak reaction of demand
– income of farmers going down
Conclusion: food prices not stable – farmers income not stable as well – the need to regulate market for agriculture products

11. How useful is information on demand elasticity (2)
change in price
Change of total expenditure, demand elastic
(E = -3)
Change of total expenditure, price elasticity (E = -1)
Change of total expenditure demand inelastic (E = 0.5)
Price going up
Decrease
No change
Increase
Price going down
increase
decrease

12. How useful is information on price elasticity of demand
How useful is information on price elasticity of demand? (3) Elasticity of demand and a seller’s revenue
Ticket’s price (euro)
Demand (thousands for 1 game)
Elasticity of demand
Seller’s revenue
(price x quantity)euro thousands per game
12.50 -∞
0.0
10.0 20
-4.00
200.0
7.50 40
-1.50
300.0
6.25 50
-1.00
312.5
5.00 60
-0.67
2.50 80
-0.25
0.00
100

13. price elasticity of demand and linear demand schedule
Q = a . P + b, where: Q=demand, P=price, a=constant, measuring the slope of d.c., b=indicates the cross point of d.c. with horizontal ax
E =∆Q/Q : ∆P/P, ∆Q/∆P = a
E= ∆Q/Q : ∆P/P = (∆Q/∆P) x (P/Q)= a x P/Q
Conclusions: 1. going up the demand schedule, a=constant, P going up, Q going down, E (absolute value) →∞
2) going down the demand schedule, a=constant, P going down, Q going up, E→0,
3) E=-1 , E= a x P/Q =-1, a x P/a x P + b=-1
E=-1 where P = -b/2a; total revenue = maximum
a= ∆Q/∆P = 10/1.25=-8, b= 100, P=-b/2a=-100/-8=6.25

14. Cross price elasticity of demand
The percentage change in the quantity od a good demanded when the price of other good increases by 1%
Goods are substitutes when the cross elasticities of demand between them are positive; goods are complements when the cross price elasticities are negative

15. Income elasticity of demand
The percentage change in quantity demanded caused by a 1% increase of income
Normal goods (clothing) – income elasticity ”+”,
2 categories of normal goods: a) luxury goods (yachts) – income elasticity > 1, b) necessities(food) – income elasticity between 0 and 1
inferior goods (low quality shoes, potatoes, bread)- income elasticity „-”

16. The price elasticity of supply
More, (commonly, elasticity of supply), - the percentage change in the quantity supplied of a good produced by a 1% change in the price, holding constant all other factors that affect quantity supplied
Elasticity of supply always „+”
Extreme cases: perfectly elastic and perfectly inelastic supply curves

17. The short run and the long run
Demand: the long run demand curve shows how quantity demanded depends on price when buyers have been able to adjust fully to price changes. A short run demand curve applies when consumers have not fully adjusted to price changes. Demand for gasoline (years) and demand for cornflakes (weeks)
Supply adjustments: the long run supply curve shows how quantity supplied depends on price when firms have time to adjust fully to price changes. A short run supply curve applies when sellers have not fully adjusted to price changes

18. Income elasticity of demand
good
Expenditure Ł
Share in the budget %
Income elasticity of demand
Normal or inferior good
Luxury or necessity good (K)
Year 1 income 100 Ł
Year 2 income 200 Ł
Year 1
Year 2 A 30 50
30 %
25%
2/3 N K B 70
30%
35%
4/3 L C 25 20
10%
-1/5 I D 15 60
15% 3

19. Income elasticity of demand
good
Expenditure Ł
Share in the budget %
Income elasticity of demand
Normal or inferior good
Luxury or necessity good (K)
Year 1 income 100 Ł
Year 2 income 200 Ł
Year 1
Year 2 A 30 50 B 70 C 25 20 D 15 60