STUDY UNIT 6 - ELASTICITY

STUDY OBJECTIVES

Define elasticity

Discuss price elasticity of demand

Indicate the relationship between elasticity and

total revenue

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 STUDY OBJECTIVES

Discuss factors that may influence price elasticity of

demand

Discuss income elasticity of demand

Discuss cross elasticity of demand

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 PRICE ELASTICITY OF DEMAND

Definition of price elasticity of demand

Formula to calculate (ep):

% change in quantity demanded
% change in price of the product

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NUMERICAL EXAMPLE
POINT ELASTICITY

QD x P
P QD
P
6 x 12
12 4 18
8 3 =1
3

Q
18 24
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NUMERICAL EXAMPLE
MIDPOINT ELASTICITY
QD
AVG QD 6
P 21 (42 2)
P AVG P 4
12 10 (20 2)

8 0,2857 (621)
0,40 (410)

Q = 0,71
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 PRICE ELASTICITY OF DEMAND

Five elasticity values:

Perfectly inelastic - Ep = 0
Elastic - Ep > 1
Unit elastic - Ep = 1
Inelastic - 0 < Ep <1
Perfectly elastic - Ep=

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PERFECTLY INELASTIC DEMAND CURVE
P D
Ep = 0

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 INELASTIC DEMAND

Habit forming products

P
D Fashionable Products
Complementary products
Products that are non-
durable
Necessities

0 < Ep <1
%P > %Qd
Q

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 UNIT ELASTIC DEMAND
P
D Ep = 1
%P = %Qd

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 ELASTIC DEMAND

Luxury products
Products that you spend a large
P
percentage of income on.
Substitute products
D
Durable products

Ep > 1
%P < %Qd

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PERFECTLY ELASTIC CURVE

Ep =

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 LINEAR DEMAND CURVE AND
ELASTICITY VALUES

R8 Ep= (Perfectly Elastic)

R7

R6 Ep>1 (Elastic)

R5

R4 Ep=1

R3
0< Ed<1 (Inelastic)
R2

R1
Ep= 0
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 PRICE, QUANTITY AND TOTAL REVENUE
Price Quantity TR = P x Q ELASTICITY VALUE
(for information only)
8 0 0 ED =
7 1000 7000 ED > 1
6 2000 12000 ED > 1
5 3000 15000 ED > 1
4 4000 16000 ED = 1
3 5000 15000 0 < ED < 1
2 6000 12000 0 < ED < 1
1 7000 7000 0 < ED < 1
0 8000 0 ED = 0
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 PRICE ELASTICITY AND TOTAL REVENUE - A
SUMMARY
COEFFICIENT CHANGE IN CHANGE IN CHANGE IN
VALUE PRICE QUANTITY TOTAL
REVENUE
Ep > 1 Increase in Price Quantity Decrease in
(elastic section) decreases Total Revenue

Decrease in Price Quantity Increase in

increases Total Revenue

COEFFICIENT CHANGE IN CHANGE IN CHANGE IN

VALUE PRICE QUANTITY TOTAL
REVENUE
0 < Ep < 1 Increase in Price Quantity Increase in
(inelastic section) decreases Total Revenue

Decrease in Price Quantity Decrease in

increases Total Revenue

Southern Business School 15

THE TOTAL REVENUE CURVE

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FACTORS INFLUENCING ELASTICITY OF
DEMAND
Luxury or necessity
Availability of substitutes
Portion of monthly income spent on product
Habit forming products
Durability of products
Time period

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FACTORS INFLUENCING ELASTICITY
OF DEMAND
Other factors influencing elasticity of demand:

Definition of product
Advertising
Number of uses of the product

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 ELASTICITY OF DEMAND - CONSUMERS

Income elasticity of demand:

Definition

Purpose:
To establish whether the product is an inferior
good or a normal good

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 ELASTICITY OF DEMAND - CONSUMERS

Inferior products Negative income elasticity (Ey < 0)

Normal products Positive income elasticity (Ey > 0)

Normal products can be divided in two categories:

Necessities 0 < EY < 1
Luxury products Ey > 1

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 ELASTICITY OF DEMAND -
CONSUMERS
Cross elasticity of demand:
Definition

Purpose:

To establish whether product is a substitute or

complement

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 ELASTICITY OF DEMAND - CONSUMERS

Complementary goods Negative cross elasticity

(Ec < 0)

Substitutes Positive cross elasticity (Ec > 0)

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Possible EXAMINATION
QUESTIONS (see graph)

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 QUESTIONS RELATING TO SLIDE
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At which prices is the price elasticity larger than one?

At which of the provided prices is the elasticity value smaller

than one?

At which price level is the price elasticity equal to 1?

Suppose the price is R10. What must happen to prices in

order to increase the total revenue?

Suppose the price is R30. What must happen to prices in

order to increase the total revenue?
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 QUESTIONS RELATING TO SLIDE
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Suppose the supply of maize increases from S0 to S2?
What happens to total revenue?

Suppose the supply of maize decreases from S3 to S2?

What happens to total revenue?

At which price will total revenue be maximised?

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