Elasticities of Demand and Supply
In the Name of God Sharif University of Technology
Graduate School of Management and Economics
Microeconomics (for MBA students) 44111 (1389-90 1st term) - Group 1 Dr. S. Farshad Fatemi
Elasticities of Demand and Supply
β’ Price Elasticity of Demand measures the sensitivity of the quantity demanded of a good to a change in its price. It is defined as: % change in quantity demanded % change in price
Or
Ξππ ππ ππ = Ξππ ππ ππ =
Negative or positive?
ππ ππππ . ππ ππππ
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 41
β’ Elastic Demand When the price elasticity (ignoring the negative sign) is greater than 1; i.e. when the % change in quantity demanded exceeds the change in price - e.g. if quantity demanded falls by 7% in response to a 5% increase in price elasticity is -7 Γ· 5 = -1.4
β’ Inelastic Demand When the price elasticity lies between 0 and 1; i.e. when the % change in quantity demanded is smaller than the change in price - e.g. if quantity demanded falls by 3.5% in response to a 5% increase in price elasticity is -3.5 Γ· 5 = - 0.7
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 42
The price elasticity varies along the length of a straight-line demand curve.
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 43
What determines the price elasticity? The ease with which consumers can substitute another good. - consumers can readily substitute one brand of detergent for another if the price rises so we expect demand to be elastic - but if all detergent prices rise, the consumer cannot switch so we expect demand to be inelastic
Demand tends to be more elastic in the long run but relatively inelastic in the short run.
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 44
When price is changed, the impact on a firmβs total revenue (TR) will depend upon the price elasticity of demand.
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 45
β’ Return to the Example of Metro Fare How should metro fares be changed to increase revenues? If passengers can use buses, taxis, and cars, then demand may be elastic and an increase in fares will reduce the number of journeys demanded and total spending. If passengers do not have travel options, then demand may be inelastic; so raising fares will have less effect on journeys demanded and revenue will improve.
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 46
β’ The Cross Price Elasticity of Demand The cross price elasticity of demand for good i with respect to the price of good j is: % change in quantity demanded of good i % change in the price of good j Ξππππ ππ ππππππ = ππ Ξππππ ππππ
Or
Negative or positive?
ππππ ππππππ ππππππ = . ππππ ππππππ
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 47
β’ The Income Elasticity of Demand The income elasticity of demand measures the sensitivity of quantity demanded to a change in income: % change in quantity demanded of a good % change in consumer income Ξππ ππ ππ = ΞπΌπΌ πΌπΌ
Or
Negative or positive?
ππ =
πΌπΌ ππππ . ππ ππππ
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 48
A NORMAL GOOD has a positive income elasticity of demand (an increase in income leads to an increase in the quantity demanded) e.g. dairy products; rice; phone calls An INFERIOR GOOD has a negative income elasticity of demand (an increase in income leads to a fall in quantity demanded) e.g. coal; potatoes - the reason we used term usually when discussed about the effect of an increase in income on demand curve A normal good might be A LUXURY GOOD which has an income elasticity of demand greater than 1; e.g. eating out, possibly furniture A NECESSITY GOOD which has a positive income elasticity of demand less than 1. Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 49
β’ Elasticity of Supply The elasticity of supply measures the responsiveness of the quantities supplied to the change in price of that good: % change in quantity supplied % change in the price Positive or negative?
Horizontal (flat) supply has an infinite supply elasticity. Vertical supply has a zero supply elasticity.
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 50
β’ Who really pays the tax? Depends on the demand and supply elasticities.
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 51
Graduate School of Management and Economics
Microeconomics (for MBA students) 44111 (1389-90 1st term) - Group 1 Dr. S. Farshad Fatemi
Elasticities of Demand and Supply
β’ Price Elasticity of Demand measures the sensitivity of the quantity demanded of a good to a change in its price. It is defined as: % change in quantity demanded % change in price
Or
Ξππ ππ ππ = Ξππ ππ ππ =
Negative or positive?
ππ ππππ . ππ ππππ
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 41
β’ Elastic Demand When the price elasticity (ignoring the negative sign) is greater than 1; i.e. when the % change in quantity demanded exceeds the change in price - e.g. if quantity demanded falls by 7% in response to a 5% increase in price elasticity is -7 Γ· 5 = -1.4
β’ Inelastic Demand When the price elasticity lies between 0 and 1; i.e. when the % change in quantity demanded is smaller than the change in price - e.g. if quantity demanded falls by 3.5% in response to a 5% increase in price elasticity is -3.5 Γ· 5 = - 0.7
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 42
The price elasticity varies along the length of a straight-line demand curve.
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 43
What determines the price elasticity? The ease with which consumers can substitute another good. - consumers can readily substitute one brand of detergent for another if the price rises so we expect demand to be elastic - but if all detergent prices rise, the consumer cannot switch so we expect demand to be inelastic
Demand tends to be more elastic in the long run but relatively inelastic in the short run.
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 44
When price is changed, the impact on a firmβs total revenue (TR) will depend upon the price elasticity of demand.
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 45
β’ Return to the Example of Metro Fare How should metro fares be changed to increase revenues? If passengers can use buses, taxis, and cars, then demand may be elastic and an increase in fares will reduce the number of journeys demanded and total spending. If passengers do not have travel options, then demand may be inelastic; so raising fares will have less effect on journeys demanded and revenue will improve.
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 46
β’ The Cross Price Elasticity of Demand The cross price elasticity of demand for good i with respect to the price of good j is: % change in quantity demanded of good i % change in the price of good j Ξππππ ππ ππππππ = ππ Ξππππ ππππ
Or
Negative or positive?
ππππ ππππππ ππππππ = . ππππ ππππππ
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 47
β’ The Income Elasticity of Demand The income elasticity of demand measures the sensitivity of quantity demanded to a change in income: % change in quantity demanded of a good % change in consumer income Ξππ ππ ππ = ΞπΌπΌ πΌπΌ
Or
Negative or positive?
ππ =
πΌπΌ ππππ . ππ ππππ
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 48
A NORMAL GOOD has a positive income elasticity of demand (an increase in income leads to an increase in the quantity demanded) e.g. dairy products; rice; phone calls An INFERIOR GOOD has a negative income elasticity of demand (an increase in income leads to a fall in quantity demanded) e.g. coal; potatoes - the reason we used term usually when discussed about the effect of an increase in income on demand curve A normal good might be A LUXURY GOOD which has an income elasticity of demand greater than 1; e.g. eating out, possibly furniture A NECESSITY GOOD which has a positive income elasticity of demand less than 1. Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 49
β’ Elasticity of Supply The elasticity of supply measures the responsiveness of the quantities supplied to the change in price of that good: % change in quantity supplied % change in the price Positive or negative?
Horizontal (flat) supply has an infinite supply elasticity. Vertical supply has a zero supply elasticity.
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 50
β’ Who really pays the tax? Depends on the demand and supply elasticities.
Microeconomics (for MBA students) Dr. F. Fatemi Graduate School of Management and Economics β Sharif University of Technology
Page 51
