The Concepts of Demand and Elasticity

1. The Concepts of Demand and Elasticity Assistant Professor Dr. Chanin Yoopetch

3. Learning outcomes By studying the end of this section students will be able to: • evaluate the work/leisure trade-off • evaluate the notion of a “leisure society” • understand and apply the concept of price elasticity of demand • understand and apply the concept of income elasticity of demand • understand and apply the concept of cross price elasticity of demand • describe simple methods of demand forecasting • evaluate techniques of demand forecasting

4. The demand for leisure • Two potential effects of an increase in income on the demand for leisure time • The substitution effect: First, an increase in income means an increase in the opportunity cost of leisure time. In this case we may expect consumers to demand less leisure time. • The income effect: Leisure time can be classed as a ‘normal service’, and in common with other ‘normal’ goods and services, as income increases more will be demanded.

5. Elasticity . . . … is a measure of how much buyers and sellers respond to changes in market conditions. . . … allows us to analyze supply and demand with greater precision.

6. Elasticity: A General Definition: The percentage (%) change in something . . . . . . given a one percent (1%) change in something else.

7. Three Types of Elasticities. . . Price • Price Elasticity of Demand • Income Elasticity • Price Elasticity of Supply Quantity

8. Price Elasticity of Demand Demand P The percentage change in the quantity demanded given. . . . . . a one percent change in the price. A B Q

9. Ranges of Elasticity . . . • Perfectly InelasticConsumers are “extremely unresponsive” to price changes. • Perfectly ElasticConsumers are “extremely responsive” to price changes. • Unit ElasticResponse is “equal to” change in price.

10. Elasticity of Demand Illustrated Perfectly Inelastic Perfectly Elastic

11. Elasticity of Demand Illustrated At any price above 4, quantity demanded = 0 Q 4 At any price under 4, quantity demanded = infinity Perfectly Elastic

12. Determinants of Price Elasticity of Demand Demand tends to be more elastic: • if the good is a luxury; • the longer the time period; • the greater the number of close substitutes; and • the more narrowly defined the market.

13. Determinants of Price Elasticity of Demand Demand tends to be more inelastic: • if the good is a necessity; • the shorter the adjustment time; • if there are few good substitutes; and • the more broadly defined the market.

14. Computing Elasticity Coefficient Percentage Change in Quantity Demanded • Computed as the percentage change in the quantity demanded divided by the percentage change in price. Price Elasticity of Demand = Percentage Change in Price

15. Income Elasticity... Types • Goods consumers regard as “necessities” tend to be income inelastic... • Examples include: food, fuel, clothing, utilities, & medical services.

17. Price elasticity of demand • Factors affecting price elasticity of demand • necessity of good or service • number of substitutes • addictiveness • price and usefulness • time period • consumer awareness • Elasticity of demand and total revenue

18. Elasticity and Total Revenue(TR) Over the Elastic Range of prices and quantity the relationship between price and total revenue is INDIRECT or OPPOSITE

19. Elasticity and Total Revenue ED > 1 then P Q TR and

20. What if the price declines in different direction? 3.00 2.00 TR 1 = 15 (3.00x5) TR 2 = 20 (2.00x10) 5 10

21. Elasticity and Total Revenue Over the Inelastic Range of prices and quantity the relationship between price and total revenue is DIRECT or THE SAME

22. Elasticity and Total Revenue ED < 1 then P Q TR and

23. What if the price declines in different direction? 3.00 2.00 TR 1 = 15 (3.00x5) TR 2 = 12 (2.00x6) 5 6

24. Income Elasticity of Demand The percentage change in the quantity demanded given a one percent change in income. (Higher income  higher demand)

25. Computing Income Elasticity Percentage Change in Quantity Demanded • Computed as the percentage change in the quantity demanded divided by the percentage change in Income. Income Elasticity of Demand = Percentage Change in Income

26. Income Elasticity... Types • Goods consumers regard as “luxuries” tend to be income elastic... • Examples include: expensive hotel rooms, luxurious spa services, sports cars, furs, and expensive foods.

27. Demand forecasting • Methods for forecasting demand (Frechtling, 2001) include: • naive forecasting • Making simple assumptions about the future (assume the 3% increase for demand) • qualitative forecasts • ‘Ranking’ the importance of factors affecting future trends (no mathematic models) • time-series extrapolation • Using a series of data (e.g. monthly data of international visitors from 1990-2009 to forecast the future arrivals of tourists in the next five years.)

28. Demand forecasting • Methods for forecasting demand (Frechtling, 2001) include: • Surveys • Where no time series data exist. Surveys can be used by acquiring data from respondents to forecast demand. • Delphi technique • Using expert opinion to forecast with the aim of reaching a consensus among the experts • Models • Complex methods involving statistical or econometric techniques to construct a comprehensive model with economic variables, such as interest rates, inflation rates, and growth rates.