1. © Pilot Publishing Company Ltd. 2005 Chapter 6 Elasticities of Demand

2. © Pilot Publishing Company Ltd. 2005 Elasticity of Demand Elasticity of Demand Classification of Elasticities of Demand Classification of Elasticities of Demand Price Elasticity of Demand Price Elasticity of Demand Price Elasticity & Demand Curve Price Elasticity & Demand Curve Price Elasticity of Demand, Total Revenue & Total Expenditure Price Elasticity of Demand, Total Revenue & Total Expenditure Income Elasticity of Demand Income Elasticity of Demand Cross Elasticity of Demand Cross Elasticity of Demand Contents:

3. © Pilot Publishing Company Ltd. 2005 Advanced Material 6.1: Price Consumption Curve and Price Elasticity Advanced Material 6.1: Price Consumption Curve and Price Elasticity Advanced Material 6.2: Income Consumption Curve and Income Elasticity Advanced Material 6.2: Income Consumption Curve and Income Elasticity Contents:

4. © Pilot Publishing Company Ltd. 2005 Elasticity of Demand

5. © Pilot Publishing Company Ltd. 2005 Elasticity of demand ( 需求彈性, E d ) is a measure of the responsiveness of the quantity demanded of a good to a change in an exogenous variable. Elasticity of demand % change in X_________ % change in exogenous variable Why?

6. © Pilot Publishing Company Ltd. 2005 Classification of Elasticities of Demand

7. © Pilot Publishing Company Ltd. 2005 Type of elasticity of demand Exogenous variable concerned Price elasticity of demand ( 價格需求彈性, p E d ) Income elasticity of demand ( 所得需求彈性, i E d ) Cross elasticity of demand ( 交叉需求彈性, c E d ) Classification according to the exogenous variable concerned Price of the good Income Price of related good

8. © Pilot Publishing Company Ltd. 2005 Classification according to the formula adopted in calculation Point elasticity of demand % Δ = X 2 – X 1 x 100% X 1 Situations applied: when the % change are _________ Arc elasticity of demand % Δ = X 2 – X 1 x 100% (X 1 + X 2 )/2 Situations applied: when the % change are _________ very small significant

9. © Pilot Publishing Company Ltd. 2005 vertical Classification according to the size of the elasticity 1. Perfectly inelastic (E d = 0) The exogenous variable changes but X remains unchanged i.e. % Δ in X =_______. In the case of price elasticity, the demand curve is _________. D 0 vertical PxPx X 0

10. © Pilot Publishing Company Ltd. 2005 Classification according to the size of the elasticity 2. Inelastic (E d < 1) %  in X ____ %  in exogenous variable 3. Unitarily elastic (E d = 1) %  in X ____ %  in exogenous variable    4. Elastic (E d > 1) %  in X ____ %  in exogenous variable

11. © Pilot Publishing Company Ltd. 2005 horizontal D Classification according to the size of the elasticity 5. Perfectly elastic (E d = infinity) A negligible change in the exogenous variable brings an infinite change in Qd i.e. % Δ in X =_________. In the case of price elasticity, the demand curve is ___________. infinity horizontal PxPx X 0

12. © Pilot Publishing Company Ltd. 2005 Price Elasticity of Demand

13. © Pilot Publishing Company Ltd. 2005 What is price elasticity? Price elasticity of demand ( 價格需求彈性, p E d ) is equal to the percentage change in quantity demanded of a good divided by the percentage change in its own price.

14. © Pilot Publishing Company Ltd. 2005 What is price elasticity? (Con’t) According to the first law of demand,  p E d is ________. negative positive However, if Giffen good existed,  its p E d would be ________.

15. © Pilot Publishing Company Ltd. 2005 ΔPxΔPx ΔXΔX X X1X1 P1P1 0 C B A Px Px DC Point elasticity of demand -- on a linear demand curve (DC) Mathematical measure: p E d at point A: Graphical measure:

16. © Pilot Publishing Company Ltd. 2005 ΔPxΔPx ΔXΔX Point elasticity of demand – on a non-linear DC X X1X1 P1P1 0 C B A P x DC Mathematical measure: p E d at point A: Graphical measure:

17. © Pilot Publishing Company Ltd. 2005 Price Elasticity & Demand Curve

18. © Pilot Publishing Company Ltd. 2005 X 0 P x Demand curve M (mid-point): | p E d |= 1 (unitarily elastic) |pEd| > 1 (elastic) |pEd| < 1 (inelastic) Point elasticity of demand -- on a linear DC

19. © Pilot Publishing Company Ltd. 2005 A D d1d1 d2d2 X O Px Px B C P E p E d at point A on d 1 = BA AC = OP PC ED DC = = p E d at point D on d 2 Price elasticity at points on different DCs If two linear DCs have the same y-intercept  they will have the same p E d at every price.

20. © Pilot Publishing Company Ltd. 2005 p E d at point A on d 1 (with a smaller y-intercept) = OP PF ED DF = p E d at point D on d 2 (with a larger y-intercept) > Price elasticity at points on different DCs AD X O P x B C P E d1d1 d2d2 F OP PC = BA AC = If 2 linear DCs have different y-intercepts  The curve with a smaller y-intercept will have a larger price elasticity than the curve with a larger y-intercept at every price.

21. © Pilot Publishing Company Ltd. 2005 D (on d 2 ) X O P x A on (d 1 ) B C P E F d1d1 d2d2 p E d at point A on a d 1 (with a larger slope) OP PF ED DF = = p E d at point D on d 2 (with a smaller slope) < Price elasticity of points on different DCs OP PC = BA AC = If 2 linear DCs intersect,  the one with a gentler slope will have a larger price elasticity at the intersection point.

22. © Pilot Publishing Company Ltd. 2005 Price Elasticity of Demand, Total Revenue & Total Expenditure

23. © Pilot Publishing Company Ltd. 2005 Total expenditure paid by a consumer = Price x Quantity transacted (or P x Q) = Total revenue received by a producer Price elasticity, total expenditure (TE) and total revenue (TR)

24. © Pilot Publishing Company Ltd. 2005 Change in TE and TR When demand or supply changes, price & quantity transacted vary. Subsequently, total expenditure & total revenue are affected.

25. © Pilot Publishing Company Ltd. 2005 D2D2 P2P2 X2X2 in TR  in TR Increase in demand D   P  & Q   TR  PxPx X D1D1 S1S1 P1P1 X1X1 0

26. © Pilot Publishing Company Ltd. 2005 D2D2 P2P2 X2X2 Decrease in demand D   P  & Q   TR  PxPx X D1D1 S1S1 P1P1 X1X1 0 in TR in TR

27. © Pilot Publishing Company Ltd. 2005 Increase in supply P  but X  Δ in TR depends on the relative % Δ in P & Q, i.e., the p E d. X S2S2 PxPx D S1S1 P1P1 X1X1 P2P2 X2X2 0

28. © Pilot Publishing Company Ltd. 2005 S2S2 a. Demand is elastic P2P2 X2X2 When supply increases, if demand is elastic, %  in X  %  in P TR  PxPx X D S1S1 P1P1 M  in TR  in TR X1X1 0

29. © Pilot Publishing Company Ltd. 2005 S2S2 b. Demand is unitarily elastic %  in X  %  in P TR remains constant  in TR  in TR P2P2 X2X2 PxPx X D S1S1 P1P1 M X1X1 0

30. © Pilot Publishing Company Ltd. 2005 S2S2 c. Demand is inelastic %  in X  %  in P TR  PxPx X D S1S1 P1P1 M  in TR  in TR X1X1 P2P2 X2X2 0

31. © Pilot Publishing Company Ltd. 2005 P  but X  Decrease in supply PxPx X D S1S1 S2S2 P2P2 P1P1 X1X1 X2X2 0 Δ in TR depends on the relative % Δ in P & Q, i.e., the p E d

32. © Pilot Publishing Company Ltd. 2005 S2S2 a. Demand is elastic When supply decreases, if demand is elastic, %  in X  %  in P Δ in TR  PxPx X D S1S1 P2P2 X2X2 P1P1 M X1X1  in TR  in TR

33. © Pilot Publishing Company Ltd. 2005 S2S2 b. Demand is unitarily elastic %  in X = %  in P TR remains constant PxPx X D S1S1 P1P1 M  in TR  in TR X1X1 P2P2 X2X2

34. © Pilot Publishing Company Ltd. 2005 S2S2 c. Demand is inelastic %  in X  %  in P Δ in TR  P2P2 X2X2 D M PxPx X S1S1 P1P1 X1X1  in TR  in TR

35. © Pilot Publishing Company Ltd. 2005 Q6.6: (a) If the demand is inelastic, to increase the TR, should a producer raise the price or should he cut the price? (b) After raising the price of a good, a producer finds that the total revenue falls. What is the reason?

36. © Pilot Publishing Company Ltd. 2005 Unit elasticity and total revenue % Δ in X = % Δ in P TR remains constant despite a change in P or Q. If one spends the whole amount (or a fixed amount) of his income on a good no matter what its price is, its p E d must be equal to / greater than /smaller than one. For a unitarily elastic demand: equal to

37. © Pilot Publishing Company Ltd. 2005 X x

38. 1.Number of close substitutes: more close substitutes  more elastic demand. Factors affecting price elasticity Why? 2. Degree of necessity: necessities & habit-forming goods  less elastic demand.

39. © Pilot Publishing Company Ltd. 2005 3. Number of possible uses: more different uses  more elastic demand. Factors affecting price elasticity (Con’t) Why? 4. Durability: more durable  more elastic demand. 5. Proportion of income spent: a larger proportion of one’s expenditure  more elastic demand. Why?

40. © Pilot Publishing Company Ltd. 2005 6. Time of adjustment: longer time for adjustment  more elastic demand (Second law of demand) Shift of DC as time passes PxPx X P0P0 P1P1 X0X0 X3X3 X2X2 X1X1 X4X4 0 Why?

41. © Pilot Publishing Company Ltd. 2005 Q6.7: The demand for salt is inelastic. List all possible reasons.

42. © Pilot Publishing Company Ltd. 2005 Income Elasticity of Demand

43. © Pilot Publishing Company Ltd. 2005 Income elasticity of demand ( 所得需求彈性, i E d ) is equal to the percentage change in quantity demanded divided by the percentage change in income. What is income elasticity?

44. © Pilot Publishing Company Ltd. 2005 Superior good  X is _________ related to income.  i E d is ________. luxuries necessities positive (Options: positive / negative / luxuries / necessities / positively / negatively ) i E d  1   i E d  1   positively

45. © Pilot Publishing Company Ltd. 2005 Inferior good  X is _________ related to income.  i E d is __________. negative (Options: positive / negative / luxuries / necessities positively / negatively) negatively

46. © Pilot Publishing Company Ltd. 2005 X I I1I1 X1X1 C 0 B A ΔXΔX Δ I Good X is an inferior good Graphical measure: Mathematical measure: X I I1I1 X1X1 C 0 B A ΔXΔX Δ I Good X is a superior good

47. © Pilot Publishing Company Ltd. 2005 Cross Elasticity of Demand

48. © Pilot Publishing Company Ltd. 2005 Cross elasticity of demand ( 交叉需求彈性, c E d ) is equal to the percentage change in quantity demanded of a good (e.g., good X) divided by the percentage change in price of another good (e.g., good Y). What is cross elasticity?

49. © Pilot Publishing Company Ltd. 2005 The cross elasticity of substitutes is positive, why? The cross elasticity of complements is negative, why? Cross elasticity of demand when P Y   Y  and X (substitute of Y)  thus, P Y and X are positively related. when P Y   Y  and X (complement of Y)  thus, P Y and X are negatively related.

50. © Pilot Publishing Company Ltd. 2005 Graphical measure: Mathematical measure: PYPY X C 0 B A ΔXΔX ΔPYΔPY X1X1 P Y1 Good X and good Y are substitutes PYPY X C 0 B A ΔXΔX ΔPYΔPY X1X1 P Y1 Good X and good Y are complements

51. © Pilot Publishing Company Ltd. 2005 Q6.9: For each of the following commodities, suggest a good with a positive cross elasticity and a good with a negative cross elasticity related to the commodity. Shoes Pencil Broom Camera Map

52. © Pilot Publishing Company Ltd. 2005 Advanced Material 6.1: Price elasticity and price consumption curve As income remains unchanged and the expenditure on good Y , the expenditure on good X must __________. As the expenditure on good X  (when Px  and X  ), the %  in X must be ___________ the %  in P X. the demand for good X must be So, the demand for good X must be _______. If PCC is _upward sloping_, when Px , both the consumption of good X and good Y __________. PCC Y X 0 increase decrease smaller than inelastic

53. © Pilot Publishing Company Ltd. 2005 Shape of PCC Consumption and expenditure on Y Expenditure on X (= I - P Y Y) Relative size of % Δ in X (  ) and P x (  ) Price elasticity of demand for X Upward sloping  %  in X %  in P x Horizontal Unchanged %  in X %  in P x Downward sloping  %  in X %  in P x < Inelastic > = Elastic Unitarily elastic

54. © Pilot Publishing Company Ltd. 2005 Price elasticity and price consumption curve Graphical measure: PCC (| p E d |<1) Y X 0 PCC (| p E d |=1) Y X 0 PCC (| p E d |>1) Y X0

55. © Pilot Publishing Company Ltd. 2005 ICC 1 ICC 2 ICC 5 ICC 4 ICC 3 Shape of ICC i E d of X i E d of Y ICC 1 ICC 2 ICC 3 ICC 4 ICC 5 Y X I1I1 I3I3 I2I2 0 Advanced Material 6.2: Income elasticity and income consumption curve +ve -ve +ve 0 0 -ve+ve

56. © Pilot Publishing Company Ltd. 2005 Correcting Misconceptions: 1. The gentler the slope of a demand curve, the larger its price elasticity. 2. A price rise must raise the total revenue. 3. If one spends a fixed amount of his income on a good, his demand for the good is perfectly inelastic. 4. It is impossible for all the goods consumed to be luxuries, because one must consume some necessities.

57. © Pilot Publishing Company Ltd. 2005 Survival Kit in Exam Question 6.1: After a rise in the price of coffee, what will happen to the total revenues of (a) coffee, (b) sugar and (c) tea respectively?