MANAGERIAL ECONOMICS

Module 3

Introduction

The previous module dealt with an exposition of the basic principles of demand and supply
in consumer economics. Starting from the basics, the lesson graduated into a discussion of
the dynamic interaction between demand and supply including the “drivers” for both.
Aside from price as the main influencer, discussion touched also other variables affecting
the behaviour of demand and supply.

As a sequel, a further exposition on the dynamic effects of prices on the demand and supply
of different products in the same markets(aka elasticity) is herein presented. Meantime,
some basic concepts.

Definition of Terms

1. Elasticity – the degree to which changes in prices affect demand and supply. Effect
are either substantial, minimal or non-existent, It can also be defined as the
responsiveness of demand/supply to a change in the price of another commodity.

2. Price elasticity – the percentage change in quantity demanded/supplied compared

to a percentage change in price.

3. Arc Elasticity - the coefficient of price elasticity of demand between two points
along the demand curve.

4. Point elasticity- the coefficient of price elasticity of demand at one point along the
demand curve.

5. Coefficient of elasticity – is the absolute value of elasticity.

6. Income elasticity of demand – percentage change in quantity demanded compared

to the percentage change in income.

7. Cross Elasticity of Demand – refers to percentage change in quantity demanded of

one good compared to the percentage change in the price of a related good.

8. Inferior Goods – goods which are bought when income levels are low, the demand
for which tends to decrease when income increases.

9. Normal Goods - goods for which demand tends to increase when income
increases.
 10. Substitute Goods – goods used in the place of each other.

11. Complementary Goods - are goods that supplement each other and are, therefore,
used together.

12. Prestige Goods - goods bought for the status and prestige they give to the
consumer , and are bought regardless of prices.

Price elasticity of demand - is the degree of responsiveness of quantity demanded to a

change in price.

percentage change∈quantity demanded

Ed =
percentage change ∈ price

change∈quantity demanded
Percentage change in quantity demanded =
original quantity demanded

change∈ price
Percentage change in price =
original price

Point Price Quantity Demanded(in kgs)

A 30 120
B 35 100
C 40 80
D 45 50

The task is to compute for the price elasticity of demand from point B to C.

5
Given: Difference in price between point B to C = = 14.3%
35

20
Difference in Quantity Demanded between point B and C = = 20%
100
 20 %
Ed =
14.3 %

Ed= 1.39% say 1.40%

How is the 1.40% interpreted?

It means that the price increase of 14.3% resulted to a reduction of demand by 20%

Guide to interpretation:

If elasticity is > 1 = elastic

< 1 = inelastic

= 1 = unitary

In the case of the computation above, the elasticicty is elastic, meaning the percentage
change in price results to a bigger change in quantity demanded. In other words, the
product is sensitive to price changes.

May it happen that even if the price of a commodity changes, the demand remains the same
or may change but not in proportion to a change in the price. Such is the elasticity of
essential commodities. It is described as an inelastic elasticity of demand. Example is rice,
water, electricity, etc.

The opposite is true for non-essential commodities and luxury goods as exemplified by the
previous computation.

Remember:

 The more essential the commodity, the more inelastic. Examples are infant
formula, electricity, salt, medicine, sugar, rice.

 Products with elasticities of > 1 are signature bags, chocolates, imported shoes,
perfumes, and the like.

Task # 1 – Compute for the Ed from the table above from 1) point A to B and 2) point C to
D. Once you have computed the coefficient of elasticity, indicate if elastic, inelastic or
unitary. Interpret in a narrative form the result of the computation. For submission to my
e-mail address on or before Monday, October 26, 2020. Include in your submission the
step-by-step procedure followed in your computation.
What are the determinants of the Price Elasticity of Deamnd?
1. Substitutability – the greater (>) the number of substitute goods, the higher (>) the
price elasticity of demand.

2. Proportion of Income – the higher the price of a product relative to one’s income,
the greater the price elasticity for it. Low priced items like chewing gum, candies
or pencils, even if their prices increase, there is a small change in quantity
demanded.

3. Luxuries vs Necessities - Luxuries(elastic); Necessities(inelastic).

To provide you an idea regarding the differentiated elasticities of demand for certain
products, the following chart is given.

Price elasticities of demand of selected

products

Product/Service Co-Efficient of Price Elasticity of

Demand
Electricity .13
Cigarettes .25
Medical Care .31
Clothing .49
Household Appliances .63
Movies .87
Beer .90
Beef 1.27
Residential Land 1.60
Lamb 2.65

To provide you a better idea of elasticities, watch the video in:

https://www.youtube.com/watch?v=HHcblIxiAAk