1 DEMAND SUPPLY DEMAND SUPPLY 2 Price Elasticity

1 DEMAND SUPPLY

DEMAND SUPPLY 2 Price Elasticity of Demand “Measures the degree of responsiveness of the quantity demanded of a commodity to changes in its prices, ceteris paribus. It involves a movement along the demand curve in response to price change” Tutorial Notes

DEMAND SUPPLY 3 Price Elasticity of Demand PED of a Good A = % % quantity demanded of good A in price of good A Tutorial Notes

DEMAND SUPPLY Price Elasticity of Demand 4 Price Elasticity of 2 Product/Service In India P P Bu rg Rice P 1 er P 0 D 1 D 0 Q 1 Q 2 Q

DEMAND SUPPLY 5 Price Elasticity of Demand (PED) Quantity Demanded For 2 Types of Food Rice Vs Burgers in India P P Rice Inelastic Burger Elastic P 1 Rev. Gained P 0 Q 1 D Q 0 Q Q Before P Increased, Revenue = P 0 XQ 0 After P increased, Revenue = P 1 XQ 1 2. For the producer of rice, his lost in revenue, red shade, is lesser than the revenue gained (yellow shade) when price is increased for rice. 3. This however is not the same for the burger that is price elastic in product. Rev. Lost P 0 1. For a price inelastic product, rice in this example, a big change in price does not extensively affect the quantity demanded of the product. Q 1 D Q 0 Q Q *Revenues is calculated as PXQ

DEMAND SUPPLY 6 Factors that Influence PED Availability of Substitutes -The more substitutes there are the greater the PED ie. the more elastic the PED of the good. The slope of the demand curve would not be very steep. -The less substitutes there is for the product, the steeper the slope of the demand curve. Time - When there is a sudden change in price of say, rice, people cannot react as fast in the short run so they will still have to suffer the increase in prices of rice. This makes the slope of the demand curve steep. But with time, when substitute for rice can be found or perhaps there is a change in taste and preference for rice, the demand curve will become less steep. Proportion of Income Spent on Commodity If you only spend a small portion of your income on the good like say a pen, the change in its price by 10% is not going to make you change your quantity demand for it by much as it is cost very little unlike a car or clothing. So the slope for these items can be steep. P D 1 D 0 Qty

Quizz 1 - Teaser 7 Q 1: The world market for Thai rice has been disrupted by protest against the government. Simultaneously, demand for rice has also been dropping owing to the change in taste and preference of the Thai people from rice to Soya Bean. Using a diagram, explain what will happen to the market price and quantity demanded for Thai rice. (5 marks) Answer 1. Draw a demand supply diagram. 2. On the diagram explain how disruption and population will shifts the demand supply curves. 3. You must explain the diagrams by saying, “Initially market equilibrium is at (P 0, QO). Subsequently owing to a disruption in supply causing the supply curve to shift to the left and population increase shifting the demand curve to the right, this have given rise to a new market equilibirum for Thai rice of (P 1, Q 1). The market clearing price is now higher (causing quantity demanded to increase less quickly) while the equilibrium quantity demanded may increase or decrease depending on the amount of shift of the demand curve to the right” P P 1 P 0 Q Q 0 Q 1

Quizz 2 - Teaser 8 Qn: Cigarettes are addictive and the government intends to curb smoking by increasing the price of cigarettes through a cigarette tax. Using an appropriate diagram, explain how the revenues of cigarette producers are affected after this price increase. (5 marks) Answer 1. Define price elasticity of demand. Revenues is calculated as PXQ P 2. Explain that smoking cigarettes is addictive and is price inelastic in demand. . 3. Draw the diagram on the right. You Inelastic P 1 Rev. Gained P 0 Rev. Lost must explain the diagram. Start by saying “initially the equilibrium price is at P 0 and quantity demanded is at Q 0. This gives rise to total revenue represented by the red shaded area. After the price has increased, the new total revenue is given by P 1 XQ 1. ” 4. Based on the diagram, it can be seen that the total revenue gained (yellow shaded areas) after the price increased is more than total revenue lost (red shaded areas). As such the producer actually benefits with greater total revenues than before as long as his product sold is prices inelastic in demand. Cigarettes Q 1 D Q 0 Q Q Before P Increased, Revenue = P 0 XQ 0 After P increased, Revenue = P 1 XQ 1

Quizz 3 - Teaser The price of corn has been increasing relentlessly ever since the US 9 Department of Transport approved biofuel (made by processing corn) as an alternative fuel to petrol. However, given the fact that many Americans are addicted to petrol, it is unlikely that drivers will switch to bio fuel in the short term. 1. Using demand supply diagram (s) , explain the relationship between corn and bio-fuel. 2. Using a demand supply diagram(s), explain the relationship between bio fuel and petrol. 3. Using a well labeled diagram, explain what the author means by saying “Americans are addicted to fuel oil”.

Quizz 3 (continued) - Teaser 10 Q 1. Bio fuel is derived from corn. As such corn is a derived demand good. This can be illustrated by the diagram below. Bio Fuel Corn Referring to the diagrams, it can be seen that when there is an increase in demand for bio fuel, this will cause the demand curve for biofuel to shift to the right. Simultaneously, this will also cause a shift of the demand curve to the rigth for corn as well.

Quizz 3 (continued) - Teaser 11 Q 2. Petrol and Bio fuel are substitutes. Their relationship can be illustrated by the diagrams below. Bio Fuel Petrol Referring to the diagrams, it can be seen that when there is an increase in demand for bio fuel, this will cause the demand curve for bio fuel to shift to the right. However, this will cause a shift of the demand curve for petrol to shift to the left as there will be less quantity demanded for petrol as bio fuel and petrol are substitutes for each other.

Quizz 3 – Continued. Q 3. Answer: 12 Q 3. “Adiction” implies that the demand for petrol for Americans is price elastic in demand. When something is price in elastic in demand it would means that the degree of change in quantity demand is not as great as the degree of change in its price This can be seen from the diagram on the right. When there is a change in the price from Po to P 1, it is noticed that the change in quantity demanded only incrrease by an amount Q 0 to Q 1 which is not as great as the degree of change in its price. As such, small change in fuel prices will not immediately cause Americans to switch over to bio fuel. P Petrol PED<1 P 0 D Q 1 Q 0 Q Q