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Elasticity and its application (KINH tế VI mô SLIDE)
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Elasticity and Its
Application
Overview
1.
2.
The Elasticity of Demand
The price elasticity of demand
The income elasticity of demand
The cross-price elasticity of demand
The Elasticity of Supply
The Elasticity
• Elasticity
– Measure of the responsiveness of
quantity demanded or quantity
supplied to one of its determinants
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1.The Elasticity of Demand
1.1 Price elasticity of demand
1.1.1 Definition: Measure of how much quantity
demanded of a good responds to 1% change in
the price of that good
EDp = %△QD /%△P
– Measures how willing consumers are
to buy less of the good as its price
rises
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The Elasticity of Demand
• Elastic demand
• Quantity demanded responds substantially to
changes in the price
• Inelastic demand
• Quantity demanded responds only slightly to
changes in the price
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The Elasticity of Demand
1.1.2 Determinants of price elasticity of demand
– Availability of close substitutes
– Necessities vs. luxuries
– Definition of the market
– Time horizon
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The Elasticity of Demand
1.1.3 Computing the price elasticity of
demand
Use absolute value (drop the minus
sign)
– Arc-elasticity of demand: Midpoint
method
(Q − Q )/[(Q2 + Q1 )/ 2 ]
•
Two
points:
(Q
1, P1) and (Q22, P2) 1
Price elasticityof demand=
(P2 − P1 )/[(P2 + P1 )/ 2 ]
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The Elasticity of Demand
E.g.
PA = 25, QA = 150
PB = 12, QB = 320
What is the AB arc
elasticity of demand?
P
A
PA
B
PB
QA
QB
Q
The Elasticity of Demand
1.1.3 Computing the price elasticity of
demand
- Point-elasticity of demand
• One points (Q*, P*)
E
D
P
%∆Q dQ / Q dQ P
P
=
=
=
× = Q' ( p) ×
%∆P
dP / P
dP Q
Q
E.g. Demand curve Q = 50- 3P. What is the
elasticity of demand at the point of P = 5
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The Elasticity of Demand
1.1.4 Variety of demand curves
(a) Demand is perfectly inelastic
• Elasticity = 0
• Demand curve - vertical
(b) Demand is inelastic
• Elasticity < 1
(c) Demand has unit elasticity
• Elasticity = 1
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The Elasticity of Demand
• Variety of demand curves
(d) Demand is elastic
• Elasticity > 1
(e) Demand is perfectly elastic
• Elasticity = infinity
• Demand curve – horizontal
The flatter the demand curve, the greater the price
elasticity of demand
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Figure 1
The price elasticity of demand (a, b)
(a) Perfectly inelastic demand:
Elasticity = 0
Price
(b) Inelastic demand:
Elasticity < 1
Price
1. an
0
1. an
Quantity
0
Quantity
The price elasticity of demand determines whether the demand curve is steep or flat.
Note that all percentage changes are calculated using the midpoint method.
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Figure 1
The price elasticity of demand (c)
(c) Unit elastic demand:
Elasticity = 1
Price
1. an
0
Quantity
The price elasticity of demand determines whether the demand curve is steep or flat.
Note that all percentage changes are calculated using the midpoint method.
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Figure 1
The price elasticity of demand (d, e)
(d) Elastic demand:
Elasticity > 1
(e) Perfectly elastic demand:
Elasticity equals infinity
Price
Price
1. an
0
1. an
Quantity
0
Quantity
The price elasticity of demand determines whether the demand curve is steep or flat.
Note that all percentage changes are calculated using the midpoint method.
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The Elasticity of Demand
1.1.5 Total revenue and price elasticity of
demand
• Total revenue - TR
– Amount paid by buyers
– Received by sellers of a good
– Computed as: price of the good times
the quantity sold
TR = P x Q
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Figure 2
Total revenue
Price
$4
1. an
P ˣ Q=$400
(revenue)
P
0
Demand
100
Quantity
Q
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The Elasticity of Demand
1.1.5 Total revenue and price elasticity of
demand
• Elastic demand: E>1
– Increase in price
• Decrease in total revenue
P2
TR2 = P2 x Q2 = S(a) + S(c)
TR2 > TR1
P1
|EpD| >1
(b)
P2
(a)
(c)
Q
1
Q2
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The Elasticity of Demand
1.1.5 Total revenue and price elasticity of
demand
• Inelastic demand
– Increase in price
|EpD| <1
P1
• Increase in total revenue
– P2
• TR2 = P2 x Q2 = S(a) + S(c)
(b)
P2
(a)
(c)
TR2
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The Elasticity of Demand
• When demand is inelastic
– Price and total revenue move in the
same direction
• When demand is elastic
– Price and total revenue move in
opposite directions
• If demand is unit elastic
– Total revenue remains constant when
the price changes
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The Elasticity of Demand
• Elasticity and total revenue along a linear
demand curve
• Linear demand curve
– Constant slope
– Different elasticities
• Points with low price & high quantity
– Inelastic
• Points with high price & low quantity
– Elastic
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Figure 4
Elasticity of a linear demand curve (graph)
Price
$7
6
5
4
1. an
3
2
Demand
1
0
2
4
6
8
10 12 14
Quantity
The slope of a linear demand curve is constant, but its elasticity is not.
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The Elasticity of Demand
1.2 Income elasticity of demand EDI
– Measure of how much the quantity
demanded of a good responds to 1%
change in consumers’ income
EDI = %△QD / %△I
– Normal goods: positive income elasticity
• Necessities: smaller income elasticities
• Luxuries: large income elasticities
– Inferior goods: negative income
elasticities
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The Elasticity of Demand
1.2 Income elasticity of demand: EDI
– Normal goods:
• Necessities:
• Luxuries:
– Inferior goods:
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The Elasticity of Demand
1.3 Cross-price elasticity of demand
– Measure of how much the quantity
demanded of one good X responds to
1% change in the price of another
good Y
Exy = %△QDx / %△Py
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The Elasticity of Demand
1.3 Cross-price elasticity of demand
• Substitutes:
• Complements:
• Independents:
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