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Elasticity Concepts Price Elasticity of Demand (Magnitude (Perfectly…
Elasticity Concepts
Price Elasticity of Demand
Definition
Degree of responsiveness of QD of good to change in its own P, cp
PED= (%:arrow_up_small: QD)/(%:arrow_up_small:P) = (:arrow_up_small:QD/:arrow_up_small:P)(P/QD)
Gradient of D curve= :arrow_up_small:P/:arrow_up_small:QD, not = PED
Negative sign indicated inverse relation
Always - for normal goods hence taken for granted, ignored
Magnitude
Price Elastic
1<
l
PED
l
<infinity
more than proportionate
change in QD, cp
due to existence of
strong substitutes
etc.
Price Inelastic
0<
l
PED
l
<1
less than proportionate
change, cp
eg.
necessities
Perfectly Price Inelastic
l
PED
l
=0
no change
, cp
no substitutes
Unit Price Elastic
l
PED
l
=1
proportionate
change, cp
hyperbolic D curve implies
unchanged TR/TE
Perfectly Price Elastic
(theoretical)
l
PED
l
=infinity
unlimited D
as long as
P does not increase
P:arrow_up_small: causes
infinite
:arrow_down:QD, cp
firm operating under
perfect competition
Applications of PED
Firms and Producers
Pricing
Strategies (for price-setters)
TR = Unit P X Q sold = TE when no tax/subsidy
Elastic: :arrow_up_small:QD greater effect on TR than :arrow_up_small:P
At original P $3000, TR is $12000, shown by area OCEG
P:arrow_up: to $4000 (33%), QD:arrow_down: >proportionately to 2units (50%). TR:arrow_down: to $8000 shown by OABF
DEGF>ABDC, hence TR :arrow_down: due to P:arrow_up:
Inelastic: :arrow_up_small:QD less effect on TR than :arrow_up_small:P
P:arrow_up:, TR:arrow_up:
PED generally varies with time
Control
Output
to Protect Income
most primary commodities are necessities, take up small portion of consumer income, inelastic
market P fluctuates significantly when S for such goods changes
S:arrow_up:, P :arrow_down::arrow_down:, <proportionate :arrow_up:QD, TR :arrow_down:
gov. may buy surplus to maintain market P and producers' TR
Government
Raise
Tax
Revenue
Indirect taxes for inelastic
COP:arrow_up:, S curve shifts left, QD:arrow_down:<proportionately
Reduce Consumption
of Undesirable Goods
Determinants
(SNIT)
Availability of
Substitutes
more and closer
substitutes -> switch to alternatives **when P:arrow_up:
no. and closeness depends on
broadness of definition
eg. X vs. X of certain brand
broader, more inelastic (includes all brands, nothing else to switch to
Degree of
Necessity
cannot delay consumption
of necessities, to sustain
basic quality of life
Goods bought on
habitual basis
hard to cut down on smoking, drinking due to
addiction
Proportion of
Income
higher proportion, more price elastic since
more difficulty paying
if P:arrow_up:
Time
Period
generally relatively
inelastic in short run
, elastic in long run as consumers take
time to adjust consumption patterns
and find suitable alternatives
