Elasticity and Its Applications-Engineering Economics-Lecture Slides, Slides of Microeconomics

Download Elasticity and Its Applications-Engineering Economics-Lecture Slides and more Slides Microeconomics in PDF only on Docsity! Module No. 04 Elasticity and Its Applications (Quantitative Demand Analysis) Engineering Economics docsity.com Elasticity of Demand  We know, from the Law of Demand, that price and quantity demanded are inversely related.  Now, we are going to get more specific in defining that relationship, … allows us to analyze demand and supply with greater precision.  We want to know just how much will quantity demanded change when price changes? That is what elasticity of demand measures.  It is a measure of how much buyers and sellers respond to changes in market conditions  Price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good.  Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price. docsity.com Degrees of Ed  Perfectly Inelastic • Ed = % Δ in Qd % Δ in P • Ed = 0___ % Δ in P • Ed = 0 it is also called zero elasticity docsity.com  Perfectly elastic demand  Ed = % Δ in Qd % Δ in P  Ed = % Δ in Qd 0  Ed = ∞ Degrees of Ed docsity.com  Relatively Inelastic or Inelastic Ed = % Δ in Qd % Δ in P Ed < 1 (in absolute value) % Δ in Qd < % Δ in P  For every 1% change in P, Qd changes by less than 1%  Quantity demanded does not respond strongly to price changes. Degrees of Ed docsity.com  Availability of Close Substitutes  Amount of Consumers Budget  Necessities versus Luxuries  Time Horizon  Availability of information concerning substitute goods Elasticity of Demand and Its Determinants docsity.com  Availability of Substitutes • The more choices that are available, the more elastic is the demand for a good. (and vice versa) • If the price of Pepsi goes up by 20%, one can always purchase Coke, 7-Up and so forth. • One's willingness and ability to postpone the consumption of Pepsi and get by with a "lesser brand" makes the PED of Pepsi relatively elastic. Elasticity of Demand and Its Determinants docsity.com  Amount of Consumers Budget • The less expensive a good is as a fraction of our total budget, the more inelastic the demand for the good is (and vice versa). • Most consumers have both the willingness and ability to postpone the purchase of big ticket items. • If an item constitutes a significant portion of one's income, it is worth one's time to search for substitutes. • A consumer will give more time and thought to the purchase of a $3000 television than a $1 candy bar, so demand for the former will be more elastic than demand for the latter. Elasticity of Demand and Its Determinants docsity.com  Availability of information concerning substitute goods  The easier it is for a consumer to locate the substitute goods, the more willing he will be to undertake the search, and the more elastic demand will be.  an attachment to a certain brand—either out of tradition or because of proprietary barriers—can override sensitivity to price changes, resulting in more inelastic demand Elasticity of Demand and Its Determinants docsity.com Price of Pen (P) Quantity Demanded (Q) T. Expenditures or Revenue (PxQ) Price Elasticity of Demand 5.00 30 150 - 4.75 40 190 E >1 4.50 50 225 E>1 4.25 60 255 E>1 4.00 75 300 E>1 3.75 80 300 E=1 3.50 84 294 E<1 3.25 87 282.75 E<1 Total Revenue and Elasticity of Demand docsity.com  When the price elasticity of demand for a good is perfectly inelastic (Ed = 0), changes in the price do not affect the quantity demanded for the good; raising prices will cause total revenue to increase.  When the price elasticity of demand for a good is relatively inelastic (0 < Ed < 1), the percentage change in quantity demanded is smaller than that in price. Hence, when the price is raised, the total revenue rises, and vice versa.  When the price elasticity of demand for a good is unitary elastic (Ed = 1), the percentage change in quantity is equal to that in price, so a change in price will not affect total revenue.  When the price elasticity of demand for a good is relatively elastic (Ed > 1), the percentage change in quantity demanded is greater than that in price. Hence, when the price is raised, the total revenue falls, and vice versa. Total Revenue and Elasticity of Demand docsity.com  Another type of elasticity is the Cross Price Elasticity. This gets at how changes in price of one good can effect the demand of another  Cross Price Elasticity of Demand (E1,2)  Cross price elasticity of demand measures the percentage change in demand for a particular good caused by a percent change in the price of another good.  It measures the responsiveness of quantity demanded of good one when the price of good 2 changes. E1,2 = % ∆ in Qd of Good 1 % ∆ in P of Good 2 Cross Price Elasticity of Demand , . yox x y y xo PQ E P Q    docsity.com  This relationship is called substitutes and can be seen when E1,2 > 0.  This relationship is called complements and can be seen when E1,2 < 0  For example, if, in response to a 10% increase in the price of fuel, the demand of new cars that are fuel inefficient decreased by 20%, the cross elasticity of demand would be: -20%/10% = -2  A negative cross elasticity denotes two products that are complements,  while a positive cross elasticity denotes two substitute products. Cross Price Elasticity of Demand docsity.com  Selected cross price elasticities of demand Good Good with price change XED Butter Margarine +0.81 Beef Chicken +0.28 Entertainment Food -0.72 Cross Price Elasticity of Demand docsity.com