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AN INTRODUCTION TO MICROECONOMICS. Dr. Mohammed Migdad. Elasticity and Its Applications. CHAPTER 3. Chapter 3 content :. Chapter three is about elasticity and its applications. It includes: Price elasticity of demand, Point and arc elasticity, Types of elasticity,
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AN INTRODUCTION TOMICROECONOMICS Dr. Mohammed Migdad
Elasticityand Its Applications CHAPTER 3
Chapter 3 content: Chapter three is about elasticity and its applications. It includes: • Price elasticity of demand, • Point and arc elasticity, • Types of elasticity, • Factors affecting elasticity, • Elasticity and total revenue, • Income elasticity of demand, • Price elasticity of supply, • In addition to elasticity and tax.
3.1 Introduction Elasticity Is a general concept that can be used to quantify the response in one variable when another variable changes.
Example 1 Consider the market for sales of ice cream cones at a state fair. The table below gives the market quantity demanded with consideration in giving all the sellers the same price. Calculate the price elasticity of demand for the ice-cram.
Ice-Cream Demand Schedule Continue
You can calculate the market price elasticity of demand using the information contained in the table above. For instance, suppose you decided to calculate the price elasticity of demand at the price $2.00 by examining a price decrease from $2.00 to $1.50 per cone. Continue
In this case, the demand for ice cream will increase from 7 million cones to 10 million cones. You can use these figures to calculate the price elasticity of demand as follows: Continue
This implies the following: • The price elasticity of demand for ice-cream cones at a price of $2.00, according to the demand schedule provided, is -1.72. Continue
The sign here illustrates the negative relation between price and quantity demanded and that we deal here with the absolute number. So the value of the elasticity in this case equals 1.75. • This elasticity means that the % change in quantity is higher than the % change in price, which indicates that the demand here is an elastic demand.
Example 2 You are a cement producer. You wish to plot your firm's demand curve and to find the price elasticity of demand at various points along the demand curve. You decide to calculate elasticity by examining the effects of price declines from $50 to $40, $40 to $30, etc.
To calculate the price elasticity of demand between a price of $50 and $40 on the demand curve, divide the percentage change in quantity demanded by the percentage change in price. Continue
Cement Demand Schedule Continue
Similarly, you can find the elasticity between prices of $40 and $30, $30 and $20, and $20 and $10. • To illustrate, here is what you will find when you calculate elasticity between $40 and $30: Continue
This is the equation of elasticity between $30 and $20: Continue
This is the equation for elasticity between $20 and $10 Continue
Notice that demand becomes increasingly less as prices fall. Intuitively, this makes sense; consumers can be expected to react much more dramatically to a change in price when prices are high than they are low.
Arc Elasticity Supposing we want to measure the elasticity between point A and point B appearing on the same curve in figure (3.1), we assume that: • P1 = 4, Qd1 = 12 • P2 = 5, Qd2 = 9
If we intend to calculate the elasticity between the two points, A and B, starting from point B and using the elasticity formula as illustrated above, this is what we get:
If we intend to calculate the elasticity between the two points, A and B, starting from point A and using the elasticity formula as illustrated above, this is what we get:
We notice some differences in the results because the starting points were different. To avoid this difference in calculating the Arc Elasticity, calculating from the middle point between both points, A and B, could be the best way. This is known as the Midpoint Law which gives an average result.
3.4Point Elasticity and Types of Demand Elasticity Point Elasticity >>> ….
3.4Point Elasticity and Types of Demand Elasticity Types of Demand Elasticity
3.4.1 Types of Price Elasticity of Demand • Elastic Demand • Inelastic Demand • Unitary Elastic Demand • Perfectly Elastic Demand • Perfectly Inelastic Demand/The Zero Elasticity
3.4.2 Special Cases for the Negative Demand Elasticity • Luxury cars, particularly at the higher end, like the Rolls-Royce Phantom pictured here, are often said to be desirable due to their price. As a result, it is argued that luxury cars are Veblen goods. • In such cases, if we measure the demand elasticity, it will be positive with positive relationship between price and quantity demanded
3.5 Elasticity and Total Revenue ExampleProduct X1 can be sold for $5. The seller decides to increase the price to $7 in order to earn more money, but finds that he earns less money. This is because he is selling fewer of the products due to the increased price. His/her total revenue is falling, as a result. The demand for this product must be elastic. The producer failed in achieving his/her aim due to the lack of knowledge about the elasticity of the good.
3.5.1The Relationship between (TR) and Elasticity, and (TE) and Elasticity • If the demand on a product was as follows, the demand on this product will be elastic Table: Total Revenue when the Price Decreases in the Elastic Demand • The demand on this product is elastic; therefore, the decrease in price causes an increase in total revenue (TR). The price decreases 20%, the quantity increases 30%, and total revenue increases 8.3%.
If the demand was unitary-elastic, total revenue remains constant no matter the price changes.
Total Revenue when the Price Decreases in the Unitary Elastic Demand The price decreases 20%, the quantity increases 20%, and total revenue remains constant.
3.6 The Relationship between Marginal Revenue, Price, and Elasticity Marginal revenue can be defined as "the change in total revenue caused by selling an additional new unit".
3.7 Elasticity and the Slop The Slope of the Infinity Elastic Demand Curve
3.7.1 The Determinants of Price Elasticity of Demand (Factors that Affect Elasticity) The elasticity differs from one good to another depending on different factors as following: • The Availability of Substitutes • Necessity of a Product • Amount of Income Spent on the Good • Consumer Income (The Wealth of Consumers) • Time
3.8 Practical Applications to Price Elasticity of Demand The Effect of Decreasing Supply on Total Revenue
3.9 Cross Price Elasticity of Demand (CPED) • CPED is the extent to which the quantity of good (y) is affected by the change in the price of good (x). Continue
