Elasticity of Demand and Supply

1. Elasticity of Demand and Supply Chapter 5

2. Price Elasticity of Demand • Price elasticity of demand measures how responsive consumers are to price change; • elasticity is another word for responsiveness • Price elasticity of demand = Percentage change in quantity demanded / Percentage change in price

3. Percentage Change Formula % change = [New – Old / Old] x 100 Example: What is the percentage change if price increases from RM5 to RM8? New price = RM8; Old price = RM5 % change = [8 – 5 / 5] x 100 = 60%

4. Exhibit 1: Demand Curve for Tacos • For the price elasticity to be a useful measure, we should come up with the same result between points a and b as we get between b and a. • To do this we must take the average of the initial price and the new price and use that as the base in computing the percent change in price a $1.10 Price b 0.90 D Price elasticity between a and b = 10% / - 20% = - 0.5 95 105 0 Thousands per day

5. Price Elasticity of Demand • Since the focus is on the percent change, we need not be concerned with how output (kg, etc) or price (RM, etc) is measured

6. Price Elasticity of Demand • Because price and quantity demanded are inversely related, the price elasticity of demand has a negative sign • For example, absolute value of the elasticity for tacos computed earlier will be referred to as 0.5 rather than –0.5

7. Categories of Price Elasticity • Three general categories 1) Inelastic (Tidak anjal atau kurang anjal) • Percent change in quantity demanded is smaller than the percent change in price, the price elasticity has an absolute value between 0 and 1.0 % Change Q < % Change P •  demand is inelastic  quantity demanded is relatively unresponsive to a change in price

8. Inelastic (Tidak Anjal atau kurang anjal) % Change Q < % Change P

9. Categories of Price Elasticity 2) Unit elastic (Anjal satu) Percent change in quantity demanded just equals the percent change in price % Change Q = % Change P • a price elasticity with an absolute value of 1.0

10. Categories of Price Elasticity 3) Elastic (Anjal) Percent change in quantity demanded exceeds the percent change in price % Change Q > % Change P the price elasticity has an absolute value exceeding 1.0  quantity is responsive to changes in price

11. Elastic (Anjal) % Change Q > % Change P

12. Ciri-ciri Keanjalan Permintaan Harga

13. Categories of Price Elasticity 4) Perfectly elastic (Anjal Sempurna) Harga berubah sedikit kuantiti akan berubah sampai tak terhingga

14. Categories of Price Elasticity 5) Perfectly inelastic (Tidak anjal sempurna) Harga berubah tapi kuantiti Tidak akan berubah

15. Mengira Peratus Perubahan • Keanjalan adalah nisbah di antara peratus perubahan. • Peratus Perubahan Harga = • Peratus Perubahan Kuantiti Permintaan =

16. Contoh Mengira Keanjalan Permintaan Harga • Jika harga meningkat dari $2 ke $3, dan kuantiti berkurangan dari 10 ke 5. Cari keanjalan permintaan harga.

17. Pengiraan = Peratus perubahan harga = Peratus perubahan kuantiti = Oleh itu, keanjalan permintaan harga =

18. Mentafsirkan Nilai Keanjalan Permintaan Harga •  = 0.2, ini bererti apabila harga meningkat 1%, kuantiti permintaan akan berkurangan sebanyak 0.2% •  = 2, ini bererti apabila harga meningkat 1%, kuantiti permintaan akan berkurangan sebanyak 2%

19. Elasticity and Total Revenue • Total revenue (TR) is the price (p) multiplied by the quantity demanded (q) at that price •  TR = p x q • What happens to total revenue when price decreases? • Lower price  producers get less for each unit sold  total revenue declines • Lower price  increases quantity demanded  total revenue increases • Overall impact of lower price on total revenue depends on the net result of these opposite effects

20. Elasticity and Total Revenue • When demand is elastic, the percent increase in quantity demanded exceeds the percent decrease in price  total revenue increases • When demand is unit elastic, the two are equal  total revenue remains unchanged • When demand is inelastic, the percent increase in quantity demanded is more than offset by the percent decrease in price  total revenue decreases

21. Determinants of Price Elasticity of Demand (Penentuan Keanjalan Permintaan Harga) • Availability of Substitutes • Proportion of Consumer’s Budget • Length of Time

22. Availability of Substitutes • The greater the availability of substitutes for a good and the closer the substitutes, the greater the good’s price elasticity of demand • The number and similarity of substitutes depend on how we define the good  the more broadly we define a good, the fewer the substitutes and the less elastic the demand

23. Proportion of Consumer’s Budget • Because spending on some goods represents a large share of the consumer’s budget, a change in the price of such a good has a substantial impact on the amount consumers are able to purchase • Generally, the more important the item is as a share of the consumer’s budget, other things constant, the greater will be the income effect of a change in price, the more price elastic will be the demand for the item

24. Exhibit 5: Demand Becomes More Elastic over Time • Suppose the price increases from the initial price of $1.00 to $1.25. • Dw shows that one week after the price increase, the quantity demanded has not changed much, from 100 to 95 • After one month, Dm, it has declined to 75, and after one year, Dy, to 50 • The longer the time period the larger the response to a given price change $1.25 1.00 Price per unit Dy Dm Dw 0 50 75 95 100 Quantity per period

25. Price Elasticity of Supply • The price elasticity of supply measures how responsive producers are to a price change • Equals the percent change in quantity supplied divided by the percent change in price • Since the higher price usually results in an increased quantity supplied, the percent change in price and the percent change in quantity supplied move in the same direction  the price elasticity of supply is usually a positive number

26. Exhibit 7: Price Elasticity of Supply

27. Exhibit 7: Price Elasticity of Supply • If the price increases from p to p', the quantity supplied increases from q to q’

28. Categories of Supply Elasticity • The terminology for supply elasticity is the same as for demand elasticity • If supply elasticity is less than 1.0, supply is inelastic • If it equals 1.0, supply is unit elastic • If it exceeds 1.0, supply is elastic

29. Exhibit 8: Constant-Elasticity Supply Curves (a) Perfectly elastic (b) Perfectly inelastic (c) Unit elastic S' t t t i i i n n n S" u u u ¥ E = 1 r r r S E = e e e S p p p $10 S p E = 0 e e e S c c c i i i r r r P P P 5 Quantity per period Quantity per period Quantity per period 0 0 0 10 20 Q At one extreme is the horizontal supply curve. Here producers will supply none of the good at a price below p, but will supply any amount at a price of p The most unresponsive relationship is where there is no change in the quantity supplied regardless of the price where the supply curve is perfectly vertical. Any supply curve that is a straight line from the origin such as shown above is a unit-elastic supply curve.

30. Income Elasticity of Demand • Measures how responsive demand is to a change in income • Equals the percent change in demand divided by the percent change in income • Categories • Goods with income elasticities less than zero are called inferior goods  demand declines when income increases

31. Income Elasticity of Demand • Normal goods have income elasticities greater than zero  demand increases when income increases • Normal goods with income elasticities greater than zero but less than 1 are called income inelastic goods  demand increases but not as much as does income • Goods with income elasticity greater than 1 are called income elastic  demand not only increases when income increases but increases by more than does income

32. Cross-Price Elasticity of Demand • Since firms often produce an entire line of products, it has a special interest in how a change in the price of one product will affect the demand for another • The responsiveness of the demand for one good to changes in the price of another good is called the cross-price elasticity of demand

33. Cross-Price Elasticity of Demand • Defined as the percent change in the demand of one good divided by the percent change in the price of another good • If an increase in the price of one good leads to an increase in the demand for another good, their cross-price elasticity is positive  the two goods are substitutes • If an increase in the price of one good leads to a decrease in the demand for another, their cross-price elasticity is negative  the two goods are complements