Lecture 3 Elasticity (1)

1. In class rules!!!

Name tags each class.
Notes and pens are compulsory.
No phones or other devices are allowed in the
class. Breach of this rule will be punished by
dismissal. Use calculators to make calculations, do
not use phones
Students are not allowed if late for more than 10
minutes, the attendance is nullified.
Leaving the class without permission is not
allowed. Your attendance will be nullified.

2. Best practices of learning

Note taking is important. Two links to Harvard
University practices and research about note
taking:
Active participation and critical thinking through
questioning is motivated

3. Lecture 3: Elasticity

By Shukhrat Shadmanov

4. Learning Outcomes

By the end of this unit, you should be able to:
Define and apply the concepts of
Price Elasticity of Demand,
Income Elasticity of Demand,
Cross Elasticity of Demand;
Price elasticity of Supply
Describe the relationship between total revenue and
elasticity.
Discuss applications of elasticities

5.

Price Elasticity of
Demand

6. Measuring elasticity using the arc method

10
P
Ped
m
8
n
Ped =
DQ
mid Q
DP
mid P
6
4
Demand
2
Q (000s)
0
0
10
20
30
40
50

7. Measuring elasticity using the arc method

10
Ped =
m
8
=
DP = –2
7
n
6
=
=
=
DQ = 10
Mid P
DQ
mid Q
DP
mid P
10
-2
15
7
10/15 x -7/2
-70/30
-7/3 = -2.33
4
Mid Q
15
2
Demand
Q (000s)
0
0
10
20
30
40
50

8. Q If the price of good X rises from $9 to $11 and as a result quantity demanded falls from 100 units to 60 units, what is the

price elasticity of demand between
these prices?
A. 2/–80 = –0.025
B.
C.
D.
E.
–80/2 = –40
0.2/–0.5 = –0.4
–0.5/0.2 = –2.5
–1

9. Price Elasticity of Demand

The absolute value of PED:
PED > 1 (elastic demand)
PED < 1 (inelastic demand)
PED = 1 (unit elasticity demand)
PED = 0 (perfectly inelastic demand)
PED = ∞ infinite (perfectly elastic demand)

10.

Determinants of price
elasticity of demand
Luxuries vs. Necessities:
The degree of substitutability (number and closeness
of substitute goods):
The definition of goods: narrow or broad
The time period: short period vs long period
Habitual: Smokers, Drinkers

11.

Identify whether the following is
elastic or inelastic demand:
Water
2. Salt
3. Holidays to the Egypt
4. Restaurant meal
5. Car
1.

12.

13.

Elasticity and Total
Revenue (TR)
Total revenue (TR) is the total earning of a firm.
It is
calculated by Price x Quantity (P x Q).
When the demand is elastic, the firm will earn a higher
total revenue if price is reduced.
When the demand is inelastic, the firm will earn a lower
total revenue if price is reduced.
When the demand is unit elastic, total revenue will not be
affected by any price change.

14. Total expenditure

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

15.

Elastic demand
Price
P1
Elastic demand
P rises: TR falls
P falls: TR rises
Loss
P2
Gain
D
D
Q1
D2
Q2
Qty demanded

16. What is the net effect on TR if price is increased from $4 to $5?

P
5
b
a
4
0
D
10
20
Q (millions of units per period of time)

17.

Inelastic demand
Price
P1
Inelastic demand
P rises: TE rises
P falls: TE falls
Loss
P2
Gain
D
Q1 Q2
Qty

18. What will be the effect on TR of increasing the price?

8
c
P
a
4
D
0
15
20
Q (millions of units per period of time)

19. PED of a linear demand

The PED is not the
same all along the
line when we have
straight line demand
curve. There is only
one point where it is
equal to 1. Above
this point PED is
greater than 1,
below smaller than
1

20.

Perfectly Inelastic demand
P
Totally inelastic demand (P D = 0)
D
P2
b
P1
a
O
Q1
P rises: TE rises
Quantity
demanded does
not change
regardless of
prices
Q

21.

Infinitely elastic demand
P
Infinitely elastic demand (P D = )
a
b
O
Perfectly Elastic
demand
P rises: TE =0
P fall: quantity
demanded is
infinite
D
P1
Q1
Q2
Q

22.

Unit elastic demand
P
20
Unit elastic demand (P D = -1)
Unitary
demand
Percentage change
(%) in quantity
demanded is the
same
as
percentage
(%)
change in price.
a
b
8
D
O
40
100
Q

23. PED and taxation

Will taxation
decrease the
quantity of
consumption more
in elastic or
inelastic demand
curve?

24.

Income Elasticity of
Demand

25.

Income Elasticity of
Demand: types of goods
For income elasticity we can differentiate these goods:
YED > 0 the good is normal
YED > 1 the good is a luxury
Consumers buy more when their income rises
YED < 0 the good is inferior
0 < YED < 1 the good is a necessity

26. Determinants of YED

degree of necessity
rate at which people are satisfied
level of income

27.

Cross Elasticity of
Demand

28. Price Elasticity of Supply

Price Elasticity of Supply measures the responsiveness of
the quantity supplied of a good to its own price.
The elasticity of supply is usually positive because price and
quantity supplied are directly related
Measuring price elasticity of supply
PES
PES is always a positive number

29. Price Elasticity of Supply

Supply curves can be characterized as:
1.
Perfectly Inelastic Supply
2.
Inelastic Supply
3.
Unit Elastic Supply
4.
Elastic Supply
5.
Perfectly Elastic Supply

30. Determinants of PES

Amount that costs rise as output increases: The more
easily sellers can change the quantity they produce, the
greater the price elasticity of supply. (E.g. The supply of
water is harder to vary and thus less elastic than the supply
of pizza.)
Time period: for many goods, price elasticity of supply is
greater in the long run than in the short run, because firms
can build new factories, or new firms may be able to enter
the market.

31.

The end… (kind of!)