Elasticities

1. Elasticities Price Elasticity of Demand Income Elasticity of Demand Cross Elasticity of Demand

2. Real world applications of Elasticity… The economic concept of “Elasticity” is used primarily by producers to predict changes in consumer demand. By how much will demand change if…… • The price of a good increases/decreases • Consumer incomes increase/decrease How do I know if a good is a compliment/substitute………..

3. A.S 3.2 Response of the Market to change…. “The description of how a market responds to change will involve a selection from: Elasticity • definitions of price elasticity of demand, cross elasticity of demand, income elasticity of demand and price elasticity of supply • calculation of price elasticity of demand, cross elasticity of demand, income elasticity of demand and price elasticity of supply • reasons for differing elasticities for different goods and services • significance for firms in their pricing decisions • supply responsiveness in the long term compared with the short term.”

4. Price Elasticity of Demand Textbook pp. 48-55 - Read & then make notes on the following Objectives: • Define Price Elasticity of Demand 2. CalculatePrice Elasticity • Percentage Change Method & Mid Point Method • Impact on Revenue* Calculation can be used to calculate elasticity & the relative elasticity of a good will determine the impact on Revenue • Describe the different elasticities of demand • Explain the factors that affect elasticity of demand

5. Price Elasticity of demand “Measures the responsiveness of the quantity demanded of a good or service to its change in price” In other words if the price is increased or decreased how much quantity demanded will change, if at all.

6. Calculations for Price Elasticity of Demand Coefficient = a pure number used to quantify Elasticity Depending on the information given there are 3 methods used to calculate elasticity: • Percentage Change (Arc) • Mid Point • Change in Revenue

7. Percentage Change Ep = % QD % P

8. Mid- Point Method Ep = Q Q1 +Q2 2 P P1 +P2 2 Ed = 0 < 1 Inelastic Ed => 1 Elastic Ed = 0 = 1 Unitary

9. Revenue Change Total Revenue 1 – Total Revenue 2 Price ↓ Revenue ↑ Price ↑ Revenue ↓ Price ↓ Revenue ↓ Price ↑ Revenue ↑ Elastic Inelastic

10. Demand Curves What does the shape of the curve tell you? H.E.V.I

11. So what does this mean? • What kind of goods or services would have elastic demand? • What kind of goods would have inelastic demand?

12. Elastic Demand

13. Inelastic Demand

14. Elasticity in application In class do activities 4.4 & 4.5 in your text book. For homework do Questions: 3, 4, 7 & 8 in your workbook.

15. Income Elasticity of Demand & Cross Elasticity of Demand Read pages 58-61 & then make notes which achieve the following aims/objectives: • Define Income & Cross-Elasticity of Demand • Calculate Income & Cross-Elasticity of Demand * • Describe how the relative elasticity indicates if a good is • Substitute or a Complement • Normal Good, Luxury, Basic Necessity or an Inferior Good * The text only has one (% ) but the mid point formula also applies

16. Cross Elasticity of Demand “Cross-Elasticity of Demand measures by how much the quantity demanded of one product will increase or decrease after a change in price of another good.” Put simply it shows if there is a relationship between goods and or services. Specifically whether they are complements or substitutes.

17. Calculations for Cross-Elasticity Either EC = % QB % PA Or Percentage Change EC= QB QB1 +QB2 2 PA PA1 +PA2 2 Mid Point Method

18. Implications…. • A positive coefficient suggests a Substitute good or service • A perfect substitute will have a very high co-efficient • If the coefficient is 0 then there is no relationship • A negative coefficient suggests a complementary good.

19. Complements & Substitutes Substitutes can be recognised by having a positive coefficient meaning that an increase in the price of one good will result in an increase in demand for the other Complements are recognised by having a negative coefficient, meaning that an increase in the price of one good will cause a decrease in demand for the other. Important “Sheer coincidence” Sometimes there is no relationship between 2 very obviously random & unconnected goods.

20. Aggregate Household Spending Back in year 11 you looked at the overall patterns of household expenditure. Specifically identifying the pattern of consumption OnNecessities, Luxuries, Savings, Inferior v Normal Goods. Because Consumers are all different their tastes & preferences and specifically spending patterns will differ. Sometimes it is not obvious or clear that a good or service is a luxury or a necessity. The Economic Concept of Elasticity helps to identify patterns between income & demand for specific types of goods & services

21. Calculations for Income Elasticity of Demand Either Ey= % QD % Y Or Ey= Q Q1+Q2 2 Y Y1 +Y2 2 Sound Familiar? The mid point formula is basically The same for all elasticity calculations. Quantity Will always stay on top

22. Implications… • A positive coefficient suggests a Normal Good • A very high coefficient suggests a luxury good • A coefficient which is less than one suggests a good is a necessity • A negative coefficient suggests an inferior good, sometimes known as a Giffen Good.

23. Types of Goods & Services…. • Normal. Goods or services that are slightly better quality. Demand for normal goods will increase as income increases. • Luxury Goods or services that are “treats, obtained via discretionary income. Demand will increase with an increase income • Necessity Basic goods or services that vital or needed for survival. • Inferior (Griffin Goods) Low quality, budget brand goods. When income increases, demand will decrease

24. Applying it…. Do activity 4.6 on p. 57/58 (Good real world example ;-) Then also add to homework/do workbook questions • Income Elasticity – p. 26 Q. 12,13 & 15 • Cross Elasticity – p. 28 Q. 19, 20 For fun …. Multiple Choice p. 29/30