Elasticity

2 When should you

change your price?

DAMIEN KING
University of the West Indies, Jamaica
1
When business is tough, utilities
?
raise rates but airlines cut fares.
Why
Why is
hasthat?
the world price of oil
?
collapsed over the last few
years?
Why are alcohol and cigarettes
?
taxed more heavily than other
commodities?

2
Outline 1Price Elasticity of Demand

2Other Types of Elasticities

3
Inelastic
Elastic

4
 Elasticity
A measure of
of responsiveness
what and to what?

5
Price Elasticity
of Demand

6
 Elasticity of
Demand
The responsiveness of
quantity demanded to
a change in price

7
P
When
price falls,
how much
does qty
demande
Elastic d rise?
Q
8
P
When
price falls,
how much
does qty
demande
Inelastic d rise?
Q
9
P
When
price falls,
Perfectly
inelastic
how much
does qty
demande
d rise?
Q
10
P
When
price falls,
Perfectly
how much
elastic does qty
demande
d rise?
Q
11
 P
How to
Measur
P% e
Elasticit
re
la
tiv
e
to
Q
Q y
%
12
 P

P%

Q% Q
13
 P
40%

2000
550
100 Q% =
5000
500 2
100
450
2000
P% =
500

20%
Q
4000 5000 6000

14
 40%

Q Q% =
2000
Q midpoint 5000
Elasticity = = 2
P 100
P midpoint P% =
500

20%

15
Elastic Inelasti
Q
>1
Q midpoint
P
Q
c
P < 1
Q midpoint

P midpoint P midpoint

16
 P
10
9
8 Elasticity
7
6
and the
5 slope of
4
3
the
2 Demand
1
Q Curve
0
0 1 2 3 4 5 6 7 8 9 10

17
 P
10
9
8
7 4
6
Q 4
5
Q midpoint 5
= 1.2

3
4
3
P 3
2
P midpoint 4.5
1
0 Q
0 1 2 3 4 5 6 7 8 9 10

18
 P
10
9
8
7 2
6
Q 2
5
Q midpoint 6
= 0.5

3
4
3
P 3
2
P midpoint 4.5
1
0 Q
0 1 2 3 4 5 6 7 8 9 10

19
The greater the
slope, the lower
the elasticity.

20
 P
10
9
8
7
Price
6 Elasticit
y and
5
4
3
2 Total
Total
1 Revenue Q Revenu
0
0 1 2 3 4 5 6 7 8 9 10 e
21
 P
10
9
8
7
Price
6 Elasticit
y and
5
4
3
2
Total
1
Q Revenu
0
0 1 2 3 4 5 6 7 8 9 10 e
22
 P
10
9
8
7
Price
6 Elasticit
y and
5
4
3
2
Total
1
Q Revenu
0
0 1 2 3 4 5 6 7 8 9 10 e
23
 P
10
9
8
7
Price
6 Elasticit
y and
5
4
3
2
Total
1
Q Revenu
0
0 1 2 3 4 5 6 7 8 9 10 e
24
A rise in price will
raise total revenue If
demand is inelastic
but reduce it if
demand is elastic.
25
 P
10
9 2/2
= 4.0
2/8
8
7
Price
6 Elasticit
y along
5
4
3
2 2/8
the
Deman
= 0.25
2/2
1
Q
0
0 1 2 3 4 5 6 7 8 9 10 d
26
 Factors Substitutability
that
Influence
Elasticity
of
Demand

27
SUEB
LSAT
SITTIU
CTITAYB
IL
Pepsi
ITY
Colas
Soft drinks
Beverages
28
 Factors Substitutability
that
Necessity
Influence
Elasticity
of
Demand

29
 Inelastic

Elastic
30
 Factors Substitutability
that
Necessity
Influence
Elasticity Budget Share
of
Demand

31
Inelastic

Elastic

32
 Factors Substitutability
that
Necessity
Influence
Elasticity Budget Share
of
Demand Time Horizon

33
Elasticity of 0.6
Demand for
Petrol
0.25
After 1 yr After 6 yrs

34
 Factors Substitutability
that
Necessity
Influence
Elasticity Budget Share
of
Demand Time Horizon

35
 2. Which way
Green peas
Estimat 8
to change
1.
ed 6
Eating Out

price if you
want more
Elasticiti 1.
Air Travel revenue?
This is why
5 airlines have
es 0.
Shoes
sales but JPS
7 applies for a
0. rate increase.
3
Electricity
0.
Coffee
3 36
Why has
the price
of oil
fallen so
sharply?
37
140

120

100
The Fall
80 in the
60

40
World
20
Oil
Price
0

38
GAS STATIONS SAY THE GAS
PRICE HASNT FALLEN WITH
THE PRICE OF OIL BECAUSE
OF THE GASOLENE REVERSE
ELASTICITY EQUILIBRIUM OR G.R.E.E.D.
DICHOTOMY

39
140

120

100
The Fall
80 in the
60

40
World
20
Oil
Price
0

41
 Effect of Elasticity: a Fall in Supply

P P

Q Q
With inelastic demand, supply changes have a large price effect.
42
 Oil and gas
drilling by
hydraulic
fracturing or
fracking

43
 P
The Fall
$100
in the
$50
World
Oil
Q Price
44
Does
drug
enforcem
ent
worsen
the
problem
of drug
crime?

45
 P Demand Supply

How
$900 enforcem
Reven ent
ue
After worsens
$400
Reven drug
ue crime
Before Q
46
 Why do
governme
nts tax
alcohol
and
cigarettes
so
heavily?

47
 P
10 Supply

Ine
9 Demand

las
Elasticit

t
8

ic
7
6 y and
5
4
Tax
3 Revenu
2
e
1
0 Q
0 1 2 3 4 5 6 7 8 9 10

48
 P
10 Supply

Ine
9 Demand

las
Ela
Elasticit

t
8 sti

ic
c
7
6 y and
5
4
Tax
3 Revenu
2
e
1
0 Q
0 1 2 3 4 5 6 7 8 9 10

49
Other Types of
Elasticity

50
 Income
Elasticity of
Demand
The responsiveness of
quantity demanded to
a change in income
51
 Normal Good Redefinition

Income elasticity > 0

Inferior Good
Income elasticity < 0

52
 Think of examples

?
of both low and
high income
elasticity goods

53
 Cross Price
Elasticity
The responsiveness of
quantity demanded to
a change in the price
If the price of one good changes,
why would ofconsumption
another ofgoodother
goods change?
54
 Substitutes Redefinition

Cross price elasticity > 0

Complements
Cross price elasticity < 0

55
 Price Elasticity
of Supply
The responsiveness of
quantity supplied to a
change in price

56
 Factors Flexibility (of production)
that
Influence Number of Producers
Elasticity
Time Horizon
of Supply

57
Identifyi High Elasticity
ng Manufactures
Digital products
different
supply
elasticiti Low Elasticity
Craft goods
es Agricultural produce

58
P
Inelastic Typical
Supply
Elastic Curve

Q
59
If you know how to calculate price elasticity
of demand, then you know how to calculate
all the elasticities.
Inco
Q
me
Q% Q midpoint
Price = =
elasticity of
demand P% P Y
YP midpoint
Y

60
 Qa
Cros Qa % Q midpoint
s
Price = = a
elasticity of
demand Pb % Pb
P midpoint
b

61
 quantit
y
supplie
d Q
Q% Q midpoint
Price = =
elasticity of
demand
suppl
P% P
P midpoint
y

62
The decision to raise or lower
1
price depends on the demand
elasticity
Elasticity is the responsiveness of
2
quantity demanded or supplied
to a stimulus
A price increase raises revenue
3
only if demand is inelastic
Elasticity of demand and supply
4
helps to explain market price
volatility

63