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SHIFTS IN DEMAND

D D P2 P1 P0 S 0 D 0 1 2 D D S

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Fuel price Hike may cut demand. Hike in price of petrol and diesel may cause a definite slowdown in demand for these items

With the prices of petrol and diesel soaring to a new high demand for used fuel efficient cars have gone up and bigger and less efficient cars like Honda Civic, Hyundai Elantra and Ford Fiesta will bring down their prices.

At present food accounts for nearly a third of Asian personal expenditure so despite rise infood prices consumption will continue to grow at the rate of 3.7% matching the supply growth of 3.7%
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Jet,Spice to cut flight routes aimed at pruning losses following hike in ATF Rates by oil companies.Record fuel costs will plunge the airline industry back into loss this year and cause a rise in prices

However the rise in costs of fuel cannot be entirely borne by the price sensitiv Customer and has to be absorbed into their own costs Glaxo Smithklines Consumer Healthcares latest offering Womens Horlicks was the best--ever launch because of its unique product design And advertising

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CONCEPT OF ELASTICITY
Responsiveness of QUANTITY DEMANDED to
a) Price b) Income c) Advertisement outlay d)Cross elasticity

Price elasticity
Ep = Percentage change in quantity demanded
Percentage change in price

Income elasticity
Percentage change in Quantity demanded Percentage change in Income

Advertisement Elasticity :
Percentage change in Quantity demanded Percentage change in Advertisement expenditure
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CROSS ELASTICITY
PERCENTAGE CHANGE IN QUANTITY DEMANDED OF X PERCENTAGE CHANGE IN PRICE OF Y WHERE X&Y ARE RELATED GOODS

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PRICE ELASTICITY OF DEMAND


RESPONSIVESS OF THE QUANTITY DEMANDED TO CHANGE IN PRICE
ep = PERCENTAGE in Qty demanded PERCENTAGE in PRICE USING CALCULAS WE GET Q P Q P P Q
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= = = =

Q INFINITISMAL IN QTY INFINITISMAL IN PRICE ORIGINAL PRICE OF GOOD

ORIGINAL QTY OF GOOD


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PRICE ELASTICITY OF DEMAND


WITHOUT USING CALCULAS

LET
ep

Q1 & P1 Q 2 & P2
= Q 2 - Q1 P2 - P1 P1 Q1

BE ORIGINAL VALUES BE NEW VALUES

EG ASSUME P1 Q1 ep =

= 5 , P2 = 20 , Q 2

= 10 = 10 = -0.5

10 - 20 10 - 5

5 20

So As PRICE

ses Qty DEMANDED FALLS BY (-0.5) 50%

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INCOME ELASTICITY (ey)


Q X Y Y Q = Q2 - Q1 X Y2 - Y1 Y1 Q1

THE FOLLOWING TABLE SHOWS THE QUANTITY DEMANDED OF MEAT AT VARIOUS INCOME LEVELS . FIND ey BETWEEN SUCCESSIVE LEVELS OF INCOME

INCOME 4000 6000 8000 16000 18000

QUANTITY (kg/ MONTH) DEMANDED ey 10 20 30 35 25 2 1.5 0.67 0.33 -2.29

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INCOME ELASTICITY (ey)


APPLY Q Q1 = Q2 - Q1 . 2 - 1 10 2000 1 Q11 4000 10 = 2

CROSS ELASTICITY (ecxy)


FIND THE CROSS ELASTICITY OF DEMAND BETWEEN (a) COKE (X) AND PEPSI (Y) (b) COKE (X) AND SUGAR (Z)

exy = Qx . Py Py Qx exZ = Qx . Pz Pz Qx
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BEFORE COMM PEPSI (Y) COKE (X) SUGAR (Z) COKE(X) P 13 8 10 8 . Py Qx Pz Qx Q 30 15 10 15 = (10 -15) X 13 11-13 15 =

AFTER P 11 8 11 8 Q 40 10 9 12

xy

= Qx Py
=

= 2.17

exz

Qx . Pz

(12 -15) 11-10

10 15

= -2

x& = x &z =

SUBSTITUTES COMPLEMENTS

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PROMOTIONAL
FORMULA

ELASTICITY

Q
A

A
Q

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Illustration (ELASTICITY USING DERIVATIVES)


THE DEMAND FOR MEAT IS GIVEN AS FOLLOWS Qm = 5850 6 Pm + 2Pc + 0.15
= Pm = Pc = INCOME OF RAVI = RS. 8000 PRICE OF MEAT = RS. 125/Kg PRICE OF CHICKEN = RS. 70/Kg

CALCULATE (A) INCOME ELASTICITY

(B) CROSS PRICE ELASTICITY (C) PRICE ELASTICITY

SOLUTION

= Qm x

Qm

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Illustration (ELASTICITY USING DERIVATIVES)


Differentiating the demand function w.r.t. we have
Qm

0.15

FROM THE DEMAND FUNCTION WE HAVE Qm = 5850 (6 x125) + (2 x 70) + 0.15 x 8000 = 5850 750 + 140 + 1200 = 6440

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SUBSTITUTING THE VALUES OF & Qm we have

Qm

ey

= 0.15 x 8000 =
6440

0.186

= 0.186

CROSS

PRICE Pc

ELASTICITY

ec =

Qm

Pc Qm Differentiating Qm w.r.t Pc we have Qm Pc = 2 70 6440 = 0.02

ec

2 x

Meat & Chicken are Substitutes

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PRICE ELASTICITY

ep =

Qm Pm X Pm Qm

Differentiating m w.r.f. to Pm we have Qm = Pm -6

ep = -6 x 125 = -0.11 6440

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Different computed price elasticities


Salt Water Coffee Cigarettes Footwear Housing Foreign travel Restaurant meals Air Travel Motion pictures Brand of coffee 0.1 0.2 0.3 0.3 0.7 1.0 1.8 2.3 2.4 3.7 5.6

Source: Sullivan and Sherin

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If the price elasticity of demand for cable TV connections is high for example greater than 1.5 and the price elasticity of demand for movies shown in theatres is less than 1 what does this imply?

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ARC ELASTICITY
LET US NOW MEASURE ELASTICITY ON A SEGMENT R S. THE PRICES AT POINT R& S ARE P0 & P1 RESPECTIVELY AND QTY DEMANDED ARE 1 AND Q0 AND Q1 RESPECTIVELY. MOVEMENT TAKES PLACE FROM R TO S AND FROM S TO R . HENCE AVERAGES OF PRICES & QUANTITY ARE TAKEN. 0 P0 P1 R S P1 0 Q0 Q1

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ARC ELASTICITY
e
p

= = =

Q1 Q0 P1 P0 Q1 Q0 P1 P0

X X X

(P0 +P1)/2 (Q0 + Q1)/2 P0 +P1 Q0 + Q1 P0 +P1 Q0 + Q1

Q P

MOVEMENT FROM R TO S (P1 P0) is -ve

MOVEMENT FROM S TOR

is -ve

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ARC PRICE ELASTICITY


1)

COMPUTE ARC ELASTICITY BETWEEN C & D MONTHLY DEMAND SCHEDULE FOR RICE PRICE Qd A 10 30 B 11 25 C 12 21 D 13 18 RICE DEMANDED P1 = 12 q 1 = 21 P2 = 13 q 2 = 18 P =1 Q = -3 epD = -3 X (12 +13) = -3 X 25 1 (21+18) 39 = -1.92 epD = -1.92
SINCE

(Q X P1 +P2) (P Q1 + Q2)

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MEASUREMENT OF PRICE ELASTICITY AT A POINT


P A O

LOWER SEGMENT
UPPER SEGMENT R O

Let us consider a demand curve AB and measure its elascity at point R. AB TANGENT TO THE DEMAND CURVE P = Slope of AB = OA

Q
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OB

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MEASUREMENT OF PRICE ELASTICITY AT A POINT


- 0B 0A Q P = - 0B x RN --(1) P Q 0A RM triangles AOB, AMR & NRB are all similar 0B = NB 0A RN ( SUBSTITUTING IN EQ (1) = - NB * RN RN RM = -NB RM = -RB ( NB/RM = RB/AR) AR Q P = =

ep
All ep

ep

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SUMMARY OF ELASTICITY MEASURES


Unitary Elastic % Q=%P Relatively Elastic % Q > % P Perfectly Elastic % P = 0 Relatively Inelastic % Q<% P Perfectly Inelastic % Q = 0
P
p

e e e e e

= > = < =

1 1 1 0

0
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e >1 e =1
p p

R ep<1

e
B

=0
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POINT PRICE ELASTICITY


DEMAND SCHEDULE FOR X PRODUCT IS GIVEN PRICE QTY DEMANDED 3 20 4 15 5 11 6 9 7 7 COMPUTE (A) POINT PRICE ELASTICITY FOR AN (1) INCREASE IN PRICE FROM RS. 5 TO RS. 6 (2) DECREASE IN PRICE FROM RS. 6 TO RS.5 (1) ePD = Q P Q P X Q P = (9-11) = -2 = (6-5) = 1

PD

-2 1 = -0.909

5 11

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RELATIONSHIP BETWEEN AR, MR AND ELASTICITY

TOTAL REVENUE ( TR)= PRICE(P) X QUANTITY (Q)


AVERAGE REVENUE (AR) =TOTAL REVENUE PER UNIT AR= R/Q =PQ/Q MARGINAL REVENUE ( MR) = ADDITIONAL REVENUE WHICH A SELLER OBTAINS BY SELLING AN ADDITIONAL UNIT MR= R Q R = P.Q ..eq1 Differentiating both sides of the equation we get MR= R Q P+ Q
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=P Q Q X P Q

+Q P ...eq2 Q

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P(1+ Q X P) P Q ELASTICITY OF DEMAND =/ep/= P Q . Q .eq3 P

Substituting the value of ep in MR Eq WE GET.Note that elasticity Of demand has a negative sign so when modulus is removed then Minus sign appears in the formula as shown below

(Since 1/e= 1/P . - Q ) Q P MR=P( 1-1/e) MR= AR(1-1/e)


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RELATIONSHIP BETWEEN ep , MR ,P and TR

E=1,MR=0,

Ep>1,MR>0, Ep<1,MR<0

TR is max and it remains same when p rises TR falls as price rises TR Rises when p rises

MR=P(1-1/E)

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Do

s1

APPLICATIONS
so

s1 so

Es=ed s1 so q1 q2 Do

Ed=inf
po s1 so q1 do P1 po s1 s1 q2 do

so
Ed=0 q1 q2

so

s0 d0 Es=infinity Es=0 d p1 po

si
s0

d0
q1 q2 q

ILLUSTRATIONS
1) GIVEN BELOW IS THE WEEKLY DEMAND AND SUPPLY FOR MILK PRICE 9 10 11 12 13 14 DEMAND 18 16 14 12 10 8 SUPPLY 18 20 22 24 26 28

(A) DERIVE THE DEMAND AND SUPPLY FUNCTION (B) AT WHAT PRICES WILL NO MILK BE DEMANDED AND SUPPLIED IN DELHI (C) FIND THE EQUILIBRIUM PRICE & QUANTITY (D) INDICATE AN INCREASE IN BOTH DEMAND AND SUPPLY (BY 6lts each) GRAPHICALLY SOLUTION FORM OF A LINEAR DEMAND FUNCTION O = + bP = Qty demanded when price = 0
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ILLUSTRATIONS
Q= bP b = Q = -2 = -2 P 1 Q = - 2P (1) PUTTING THE VALUE OF b IN eq (1) WE GET 10 = -2 (13) = 36

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DEMAND FUNCTION = Qd = 36-2P

(2)

SUPPLY FUNCTION : FOR EVERY ONE RS. IN PRICE LEVEL SUPPLY OF MILK ses BY 2 LAKH Qs = 2 P (3) (B) WHEN NO MILK IS DEMANDED DEMAND FUNCTION IS AS FOLLOWS Q=0 Q= 36-2P 2P = 36 P = 36/2 =18 WHEN NO MILK IS SUPPLIED

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PROBLEMS FOR PRACTICE

A FIRM PRODUCING PRODUCT X FACES THE FOLLOWING DEMAND FUNCTION


Qx =12000 5000 Px + 5I + 500 Pc Px =Price of product I = Income per capita Pc = Price of competing good 1) Determine what effect a price increase will have on total revenues 2) If per capita income rises by 5% next year what is the effect on sales of Good X 3) Assess the probable impact of competing firm changing its prices
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FIND OUT INCOME ELASTICITY OF DEMAND BETWEEN SUCCESSIVE RANKS


INCOME/ MONTH QTY/ MONTH 400 10 600 20 800 30 1000 35 1200 38 1400 39 1600 50 1800 25

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GIVEN THE FOLLOWING DATA Px 2.50 2.75 2.75 3.00 Py 3.00 3.25 3.50 3.50 Qx 600 650 700 650

*Can we compute price elasticity of demand between a price of 2.50 and 2.75? Why orWhy not? *What is the cross elasticity of demand of X w.r.t Y between price of 3.25 and 3.50 *What is its own price elasticity of demand for X between a price of 2.75 and 3.00? *Is X a normal good *Are X& Y substitutes or complements
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D D D E0 S S1 D S0 S1

P0 S

E1 S0 D S1

D S1
D 0

D
Q0

Q1

EXPLAIN THE EFFECT OF THE FOLLOWING ON THE DEMAND CURVE.


ALL SPEED BREAKERS ON MOTORWAYS ARE ABOLISHED : DD CURVE FOR PETROL MINIMUM AGE FOR DRIVERS INCREASED TO 21 YRS DD CURVE FOR MOPEDS.
INSURANCE PREMIUM FOR FIRE ACCIDENTS INCREASED : DO CURVE FOR FIRE ACCIDENTS POLICIES.

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