1. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 1

2. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 2 Elasticity and its Application 4 CHAPTER

3. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 3 Elasticity is an important concept as it is vital and applicable in the daily of households, lives businesses and researchers. Elasticity it is not limited to the concept of demand, supply and income elasticity but also to the concept of growth and development. INTRODUCTION TO ELASTICITY

4. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 4 Elasticity measures the magnitude of responsiveness of any variable to a change in one of the determinant’s factors. For example, quantity demanded or supplied would change if price or income changes. DEFINITION TO ELASTICITY

5. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 5 The value of elasticity can be measured by: Elasticity =Percentage change in Quantity Demanded Percentage change in Quantity Supplied FORMULA OF ELASTICITY

6. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 6 Policy makers, producers and consumers use elasticity in their daily decision making. Firms use the application of elasticity to determine the substitution of inputs if one of the inputs price goes up. Policy makers use the application of elasticity to determine which factors contribute most to the growth of the Gross Domestic Product (GDP). APPLICATION OF ELASTICITY

7. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 7 Price elasticity of demand Price elasticity of supply Cross price elasticity Income elasticity TYPES OF ELASTICITY

8. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 8 Measures how much the quantity demanded of a good responds to a change in the price of that good. It is computed as a percentage change in quantity demanded divided by a percentage change in price. PRICE ELASTICITY OF DEMAND

9. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 9 The point formula is used to calculate the price elasticity of demand between two points on a demand curve. The formula is shown below: Price elasticity : Percentage Change in Quantity Demanded Percentage Change in Price FORMULA FOR PRICE ELASTICITY OF DEMAND USING THE POINT FORMULA

10. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 10 Computes a percentage change by dividing the change by the midpoint (average) at the initial and endpoint. The formula is shown below: FORMULA FOR PRICE, ELASTICITY OF DEMAND USING THE MIDPOINT FORMULA (CON’T) Q 1 -Q 0 (Q 1 -Q 0 )/2 [] P 1 -P 0 (P 1 -P 0 )/2 [] X  Q  P (P 0 + P 1 )/2 (Q 0 + Q 1 )/2 =

11. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 11 Elastic, E>1 Inelastic, E < 1 Unit Elastic, E = 1 Perfectly Inelastic, E = 0 Perfectly Elastic, E =  TYPES OF PRICE ELASTICITY OF DEMAND

12. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 12 FACTORS AFFECTING ELASTICITY OF DEMAND Availability of close substitutes Necessities versus luxuries Market Time horizon Proportion of consumer’s expenditure

13. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 13 PRICE ELASTICITY AND TOTAL REVENUE Inelastic:P  Q  TR  P  Q  TR  Elastic :P  Q  TR  P  Q  TR 

14. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 14 At points with low price and high quantity, the demand curve is inelastic. At points with high price and low quantity, the demand curve is elastic. ELASTICITY OF A LINEAR DEMAND CURVE Unitary elasticity is equal to 1

15. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 15 INCOME ELASTICITY OF DEMAND Measures how much the quantity demanded of a good responds to a change in consumers income. It is computed as a percentage change in quantity demanded divided by a percentage change in income.

16. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 16 FORMULA FOR INCOME ELASTICITY OF DEMAND The formula for income elasticity of demand is shown below: = Income elasticity of demand Percentage Change in Quantity Demanded Percentage Change in Income

17. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 17 THE USES OF INCOME ELASTICITY Used to classify goods into luxury goods, normal goods, necessary goods or inferior goods. Used to predict market potential. If one good has a high value income elasticity, the producer can predict an increase and decrease in sales when the elasticity coefficient falls.

18. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 18 DEGREES OF INCOME ELASTICITY E Y = 0, perfectly elastic necessary goods E Y >0, elastic, luxury goods 0 < E Y < 1, inelastic, normal goods E Y < 0, negative elastic, inferior goods

19. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 19 CROSS PRICE ELASTICITY OF DEMAND Measures how the quantity demanded of a good responds to a change in the price of another good. It is computed as a percentage change in quantity demanded of good 1 divided by the percentage change in the price of good 2.

20. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 20 FORMULA FOR CROSS PRICE ELASTICITY OF DEMAND The formula for cross price elasticity of demand is shown below: Cross pricePercentage change in quantity elasticity ofdemanded of good 1 demand Percentage change in price of good 2 =

21. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 21 DEGREE OF CROSS PRICE ELASTICITY

22. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 22 PRICE ELASTICITY OF SUPPLY Measures how much the quantity supplied of a good responds to a change in price of that good. It is computed as a percentage change in the quantity supplied divided by a percentage change in price.

23. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 23 The formula of price elasticity of supply is shown below: FORMULA FOR PRICE ELASTICITY OF SUPPLY Percentage change in quantity demanded supplied Percentage change in price = Price elasticity of supply

24. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 24 TYPES OF PRICE ELASTICITY OF SUPPLY Elastic, E >1 Inelastic, E < 1 Unit Elastic, E = 1 Perfectly Inelastic, E = 0 Perfectly Elastic, E = 

25. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 25 FACTORS AFFECTING ELASTICITY OF SUPPLY Flexibility of sellers to produce Time period Technology improvement Availability and mobility of factors of production Perishability

26. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 26 APPLICATION OF CONCEPT OF ELASTICITY- TAXES AND SUBSIDIES The imposition of tax on goods is an example of government intervention in the market. Subsidies are another example government intervention in the market.

27. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 27 BURDEN OF TAXES When the government imposes tax on sellers for each unit of good they sell, the tax imposed will cause customers to buy at different prices than what is received by the sellers. Tax will be a burden to a seller in terms of lower price received for each unit of good sold.

28. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 28 EFFECT OF TAX ON THE EQUILIBRIUM

29. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 29 SUBSIDY Subsidy is a direct or indirect payment, economic concession, or privilege granted by a government to private firms, households or other governmental units in order to promote a public objective.

30. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 30 BENEFITS OF SUBSIDY When a subsidy is given to the producer, the cost of producing is reduced. This means that the supply curve will shift to the right which shows that the equilibrium quantity rises.

31. All Rights ReservedMicroeconomics © Oxford University Press Malaysia, 2008 4– 31 EFECT OF SUBSIDY ON THE EQUILIBRIUM