Elasticity & case studies

1. Elasticity & case studies 1- Price elasticity of demand

2. 1- What is Ed? • 2- How to calculate Ed? • 3- Different values of Ed & shapes of Demand curves. • 4- Relation between changes in price, changes in revenues & Ed. • 5- What determines Ed?

3. What is Ed? • It is a measure that shows how the % change in quantity demanded of a product RESPONDS to the % change in the price of the product itself, other factors being constant.

4. How to measure Ed? • Ed= % change in Qdx / % change in Px • Ed=change in Q/change in P . P/Q • Example: If the quantity demanded of a certain product increased by 80% when its price fell by 20%, calculate Ed. What does the value show? • Ed=+80%/-20%= -4(every 1% change in P yields 4% in Q , in the inverse direction)

5. Another example • Calculate Ed from the following table using the point elasticity of demand, the original situation was ( A): • P Q • A)100 100 • B)90 140 • Ed= 40/-10 . 100/100=-4( notice that addressing the absolute value, Ed is more than unity, ie % change in Q RESPONDS GREATLY to % change in P.

6. 3-Different values of Ed & shapes of demand curves • 1-Ed might be Zero.Demand is PERFECTLY INELASTIC • Meaning: Qd does not respond whatsoever to P changes. The Qd remains constant , regardless of price changes. • Example: Vital necessities with no substitutes. • Demand curve is vertical as seen in the following diagram:

7. Shape of PERFECTLY INELASTIC Demand curve: It is vertical:

8. 2-Ed= infinity • Demand for the product is perfectly elastic. • Meaning: consumers are ready to buy an infinite quantity at a certain price & none at all at a slightly higher price. • Example: Very luxurious products with endless number of substitutes( the product is not important whatsoever for the consumer • Demand curve will be horizontal as follows:

9. Shape of a perfectly elastic demand curve. • It is horizontal:

10. 3-Ed=1 • Demand is of unit elasticity. • Meaning:% change in Qd =% change in P • Demand curve takes shape of a rectangular hyperbola( area under the curve which reflects REVENUE is always constant) as follows:

11. A demand curve of unit elasticity • Revenues are always constant under the curve:

12. 4- Ed is more than unity(Demand is elastic) • Meaning: % change in Q exceeds % change in P • Example: when price rises by 10%, Quantity falls & responds greatly , by 50%( Ed =- 5, as an absolute value Ed is more than 1. • It is the case of a product that has many substitutes & is not important to the consumer. • Demand curve is relatively flat( versus the following fifth last case). The diagram is as follows:

13. A relatively elastic demand curve

14. 5-Ed is less than unity.Demand is inelastic • Meaning: % change in Q is less than the % change in P. • Example: When price rises by 10%, Quantity demanded falls slightly by 2%. Thus the value of Ed is - 0.5 ( less than one, as an absolute value). • Real case study: it might be a necessary product to the consumer, & it had few substitutes. The demand curve will be relatively steep versus the previous case.

15. Demand curve that is relatively inelastic:

16. 5- Relation between changes in price, changes in revenues & Ed. • Definitely total revenue is just equal to total spending ( P . Q) • If demand for the product is elastic( eg. When price falls by 10%, quantity demanded increases greatly , by 50% for instance, thus offsetting the decrease in price & total revenue increases. Thus if demand is elastic, seller should lower the price to boost revenues.

17. This can be seen from the following diagram:

18. If demand for the product is inelastic ( eg when price rises by 20% , quantity demanded falls slightly by 5% , for instance, thus price change offsets quantity change & total revenues increase. • Thus, if demand is inelastic it is for the benefit of the seller to increase the price to receive more of a revenue.

19. The following diagram shows the previous case;

20. If demand for the product is of unit elasticity( eg. A fall in price by 10% is offset by an increase in quantity by 10%, thus leaving revenues constant.) This can be seen in the following diagram:

21. The diagram shows that the total revenue ( Or total spending from consumer’s side is constant regardless of price changes.

22. 5- What determines Ed? • Main determinants are: • The more important & necessary the product is , the less the elasticity .( demand is inelastic for necessities & elastic for products that are not important for the consumer). • The more the number of substitutes , the more the elasticity( the demand is elastic for a product with many substitutes & inelastic in case of few substitutes). • The longer the time period , the more the elasticity.

23. Cases to comment on: • 1- TWA company was seeking to maximize revenues. Top managers advised the company to increase the prices of the VIP class & to decrease the prices of the economy class on the same flight. • 2-Directly after the October War in 1973, many Arab countries were able to maximize petroleum revenues as the price per barrel increased by 4 fold. However, afterwards, the foreign importing • countries set strategies to confront the unfavorable supply shock.

24. 3- The prices of some goods seem to fluctuate more than others as a result of a decrease in supply, prove that the price elasticity of demand is behind such price fluctuations. • HINT : the less the elasticity the more the price fluctuations.

26. Price Elasticity of Supply • 1- What is Es? • 2- How to measure Es? • 3- different values of Es & shapes of Supply curves. • 4- what determines Es?

27. 1-What is Es? • Es is a measure that shows how % change in quantity supplied of the product RESPONDS to the % change in the price of the product, other factors being constant.

28. 2-How to measure Es? • Es= % change in Qs/ % change in price. • Es= change in Qs/change in P . P/Q • Eg. Calculate Es if you know that the quantity supplied of a product increased by 40% when its price increased by 10%. • Answer: Es = =40%/=10%=4( every 1% change in price yields 4% changes in qs( in the same direction)

29. Calculate Es from the following table using point elasticity of supply • Assume that A) is the original situation: • P Qs • A) 10 100 • B) 60 900 • Es= 800/50.10/100= 1.6( more than 1, thus supply is elastic)

31. 3- Different values of Es & shapes of Supply curves • 1- Es= zero ( Supply is perfectly inelastic) • Meaning: Qs is constant regardless of price changes , eg. Crop with no inventories in the very short run. • Supply curve is vertical as following:

32. Supply curve that is perfectly inelastic:

33. 2- Es= infinity( supply is perfectly elastic) • Meaning EG. Suppliers supply all they can at a certain price & none at a slightly lower price. • Supply curve is horizontal as following:

34. 3-Es=1 ( supply is of unit elasticity) • Meaning :% change in Qs=% change in P • Supply curve originates from the origin ( or its extension starts from the origin) as:

35. 4- ES is more than 1( supply is elastic) • Meaning :% change in Qs exceeds % change in P. The supply curve is relatively flat versus the coming last case, it intersects the horizontal axis) as:

36. 5- Es is less than 1( supply is inelastic) • Meaning: % change in Qs is less than % change in P. Supplier CANNOT respond GREATLY to the price signals. Supply curve is relatively steep versus the previous case , it intersects the horizontal axis as:

38. 4- what determines Es? • 1- The more efficient & sufficient the resources are the more the elasticity. • 2- The longer the period of time, elasticity usually increases