1. Elasticity 1. A definition & determinants of elasticity Price elasticityPrice elasticity 2. Elasticity & consumer expenditure 3. Measurement of elasticity Arc methodArc method Point methodPoint method 4. Other measures of elasticity

2. 1. Definitions and determinants  If price rises, demand will fall By how much?By how much? Responsiveness of demand – elasticityResponsiveness of demand – elasticity  Definitions ‘the responsiveness of demand and supply to changes in price’ ‘the responsiveness of demand and supply to changes in price’ Price elasticity of demand (P  d) : Price elasticity of demand (P  d) : ‘The responsiveness of quantity demanded to a change in price’‘The responsiveness of quantity demanded to a change in price’

3. fig Quantity Price O Q2Q2 Q1Q1 P1P1 S1S1 D a Market supply and demand

4. Quantity Price O Q2Q2 Q1Q1 P1P1 P2P2 b S2S2 S1S1 D a Market supply and demand

5. fig Quantity Price O Q3Q3 Q2Q2 Q1Q1 P1P1 P2P2 P3P3 c S2S2 S1S1 D D'D' a b Market supply and demand

6. Determinants of P  d  Why does the price elasticity vary? 1. number and closeness of substitute goods1. number and closeness of substitute goods The larger the number of substitute goods (that satisfy the same need), the greater (P  d) will be The larger the number of substitute goods (that satisfy the same need), the greater (P  d) will be E.g. holidays v. electricity E.g. holidays v. electricity 2. the proportion of income spent on the good2. the proportion of income spent on the good If this is high, a price rise will force a substantial reduction in demand If this is high, a price rise will force a substantial reduction in demand 3. Time3. Time Time to adjust spending patterns Time to adjust spending patterns Short run – inelastic Short run – inelastic Long run - elastic Long run - elastic

7. 2. Elasticity and consumer expenditure  Total expenditure (TE) = P x Q = Total Revenue (TR) See figure

8. Consumers’ total expenditure = firms’ total revenue = £2 x 3m = £6m P(£) Q (millions of units per period of time) D Total expenditure

9. Elasticity & consumer expenditure  What happens to TE (and TR) as price changes? A) elastic demand A) elastic demand P , Q  proportionately more (TE  )P , Q  proportionately more (TE  ) P , Q  proportionately more (TE  )P , Q  proportionately more (TE  )

10. P(£) Q (millions of units per period of time) 0 a D 4 20 Elastic demand between two points

11. P(£) Q (millions of units per period of time) 0 b a D 5 4 10 20 Expenditure falls as price rises Elastic demand between two points

12. Elasticity & consumer expenditure B) inelastic demand B) inelastic demand P , Q  proportionately less (TE  )P , Q  proportionately less (TE  ) P , Q  proportionately less (TE  )P , Q  proportionately less (TE  )

13. Inelastic demand between two points P(£) Q (millions of units per period of time) 0 a D 4 20

14. P(£) Q (millions of units per period of time) 0 c a D 8 4 15 20 Expenditure rises as price rises Inelastic demand between two points

15. P Q O Q1Q1 P1P1 P2P2 D b a Totally inelastic demand (P  D = 0)

16. P Q O Q1Q1 P1P1 Q2Q2 D b a Infinitely elastic demand (P  D =  )

17. P Q O 40 20 100 D 8 a b Unit elastic demand (P  D = -1)

18. 3. Measurement of elasticity  Elasticity varies along the demand ( & supply) curve Price-elastic (>1) Price-elastic (>1) price-inelastic(0-1) price-inelastic(0-1) unitary (=1) unitary (=1)  (1) arc method (between two points on D) price elasticity of demand:  Q/Q ÷  P/P price elasticity of demand:  Q/Q ÷  P/P using the average or 'mid-point' method using the average or 'mid-point' method  Q/average Q ÷  P/average P  Q/average Q ÷  P/average P

19. P (£) Q (000s) m n  Q  P mid Q mid P  P  d = Demand Measuring elasticity using the arc method

20. P (£) Q (000s) m n  Q  P mid Q mid P  P  d = 10  2 15 7  = = 10/15 x  7/2 =  70/30 =  7/3 =  2.33 Demand Measuring elasticity using the arc method

21. Measurement of elasticity  (2) The Point Method Price elasticity of demandPrice elasticity of demand dQ / dP x P / Q dQ / dP x P / Q ‘d’ – infinitesimally small change (see calculus)‘d’ – infinitesimally small change (see calculus) dQ / dP – rate of change of quantity demanded with respect to pricedQ / dP – rate of change of quantity demanded with respect to price

22. P Q 50 30 0 40 100 D r P  d = (1 / slope) x P/Q Measuring elasticity at a point

23. P Q 50 30 0 40 100 D r P  d = (1 / slope) x P/Q = dQ/dP i.e. invert dP/dQ (-50/100) =  100/50 =-2 =  /40) = -2 (0.75) =  1.5 Measuring elasticity at a point

24. 4. Other measures of elasticity  Income elasticity of demand ‘…the responsiveness of demand to a change in consumer income, Y.’ ‘…the responsiveness of demand to a change in consumer income, Y.’ Luxuries (>1), necessities (0-1),inferior goods( 1), necessities (0-1),inferior goods(<0)  Cross-price elasticity of demand ‘…responsiveness of demand for one product to a change in the price of another product.’ ‘…responsiveness of demand for one product to a change in the price of another product.’ Substitutes or complements Substitutes or complements  Price elasticity of supply Definition & determinants? Definition & determinants?