STUDY UNI T 6 ELASTICITY 1 STUDY OBJECTIVES

STUDY UNI T 6 ELASTICITY 1

STUDY OBJECTIVES n Define elasticity n Discuss price elasticity of demand n Indicate the relationship between elasticity and total revenue 2

STUDY OBJECTIVES n Discuss factors that may influence price elasticity of demand n Discuss income elasticity of demand n Discuss cross elasticity of demand 3

PRICE ELASTICITY OF DEMAND n Definition of price elasticity of demand n Formula to calculate (ep): % change in quantity demanded % change in price of the product 4

PRICE ELASTICITY OF DEMAND n Formula to calculate (ep): ∆Q Q ∆P P 5

NUMERICAL EXAMPLE 6 (24 -18) 18 4 (12 -8) 12 P 12 0, 33 (6÷ 18) 0, 33 (4÷ 12) 8 18 24 =1 Q 6

PRICE ELASTICITY OF DEMAND n Five elasticity values: – Perfectly inelastic - Ep = 0 – Elastic - Ep > 1 – Unit elastic - Ep = 1 – Inelastic - 0 < Ep <1 – Perfectly elastic - Ep= 7

PERFECTLY INELASTIC DEMAND CURVE P D ED = 0 Q 8

INELASTIC DEMAND P Habit forming products D Fashionable Products Complementary products Products that are non-durable Necessities 0 < Ed <1 %∆P > %∆Qd Q 9

UNIT ELASTIC DEMAND P D Ep = 1 %∆P = %∆Qd Q 10

ELASTIC DEMAND Luxury products Products that you spend a large percentage of income on. P D Substitute products Durable products Ep > 1 %∆P < %∆Qd Q 11

PERFECTLY ELASTIC CURVE Ep = ∞ 12

Linear Demand Curve And Elasticity Values Ep= (Perfectly Elastic) Ep>1 (Elastic) Ep=1 0< Ed<1 (Inelastic) Ep = 0 14

PRICE, QUANTITY AND TOTAL REVENUE Price 8 Quantity TR = P x Q ELASTICITY VALUE (for information only) 0 0 ED = 7 1000 7000 ED > 1 6 2000 12000 ED > 1 5 3000 15000 ED > 1 4 4000 16000 ED = 1 3 5000 15000 0 < ED < 1 2 6000 12000 0 < ED < 1 1 7000 0 < ED < 1 0 8000 0 ED = 0 15

THE TOTAL REVENUE CURVE 16

FACTORS INFLUENCING ELASTICITY OF DEMAND n Luxury or necessity n Availability of substitutes n Portion of monthly income spent on product n Habit forming products n Durability of products n Time period 18

FACTORS INFLUENCING ELASTICITY OF DEMAND Other factors influencing elasticity of demand: n Definition of product n Advertising n Number of uses of the product 19

ELASTICITY OF DEMAND - CONSUMERS n Income elasticity of demand: – Definition – Purpose: • To establish whether the product is an inferior good or a normal good 22

ELASTICITY OF DEMAND - CONSUMERS n Inferior products – Negative income elasticity (Ey < 0) n Normal products – Positive income elasticity (Ey > 0) n Normal products can be divided in two categories: – Necessities 0 < EY < 1 – Luxury products Ey > 1 23

ELASTICITY OF DEMAND - CONSUMERS n Cross elasticity of demand: – Definition – Purpose: • To establish whether product is a substitute or complement 24

ELASTICITY OF DEMAND - CONSUMERS n Complementary goods – Negative cross elasticity (Ec < 0) n Substitutes – Positive cross elasticity (Ec > 0) 25