Microeconomics Lecture Gap Sheets - way

Lecture 4 – Elasticity
Part 1 – Price Elasticity of Demand

1.1 Review of Law of Demand and Law of Supply

Lecture 4 Elasticity
• Law of demand
price and quantity inversely related
Price of cinema tickets
• Law of supply
price and quantity directly related increases from $10 to $12.
•
does not tell us as _______ changes, how ________ quantity demanded
From the law of demand,
changes or quantity supplied changes quantity demanded will fall.
• Example
Question 1
o Price of cinema tickets increase from $10 to $12 How much will the quantity fall ?
 How much does the quantity demanded fall? Question 2
 Would revenue rise or fall? Will revenue increase or decrease ?

1.2 Price Elasticity of Demand

• ________________________ of the quantity demanded to a change in price, ceteris paribus

Change in quantity demanded is _________________ Change in quantity demanded is ________________

to a change in price, ceteris paribus to a change in price, ceteris paribus

Price ΔP = Price ΔP =
A A
$20 ΔQ = ΔQ =
$20

B B
$10 $10
D

10 15 Quantity 10 30 Quantity
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 Microeconomics Lecture Gap Sheets - way

1.2 Calculating Price Elasticity of Demand

Change in quantity demanded x 100%

PED = % change in quantity demanded = Average quantity demanded =
% change in price Change in price x 100%
Average price
Example

Price Price
A
A
$20
$20

B
B $10
$10
D

10 30 Quantity
10 15 Quantity

PED = PED =

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1.4 Different Types of Price Elasticity of Demand PED = % change in quantity demanded
% change in price Elastic Demand
1 Elastic Demand PED > 1 Price PED = ______________________

B
• % Δ in Qty Demanded % Δ in Price ________________ slope

10%
A
• Change in quantity demanded is _____________________ to change in price.

• _________ slope
20% Quantity

Inelastic Demand

2 Inelastic Demand PED < 1 Price PED =

B
 % Δ in Qty Demanded % Δ in Price
10% _____________ Slope

 Change in quantity demanded is _______________________ to change in price. A

 __________ slope

Quantity
2%

. Elastic Demand
Unit
3 Unit Elastic Demand PED = 1 Price

 % Δ in Qty Demanded % Δ in Price

PED = 1

 Parabola shape
3

Quantity
 Microeconomics Lecture Gap Sheets - way
Perfectly Elastic Demand
.
4 Perfectly Elastic Demand PED =
Price
PED =
• Quantity demanded is ______________________ to change in price
Horizontal Demand Curve

• Horizontal demand curve

Quantity

5 Perfectly Inelastic Demand PED = Perfectly Inelastic Demand

.

• Quantity demanded is completely____________ to change in price Price

PED =
• Vertical demand curve

Vertical Demand Curve

How to remember/differentiate the various elasticities and their corresponding diagrams ?

Quantity

Perfectly Elastic Demand

. Inelastic Demand Perfectly Inelastic Demand
Elastic Demand
Price .
PED > 1 PED = Infinity Price PED < 1 Price
Price
PED = 0
Flatter slope Horizontal Demand Curve
Steeper Slope
Vertical Demand Curve

Quantity Quantity Quantity 4

Quantity
 Microeconomics Lecture Gap Sheets - way

1.5 Elasticity Along A Straight Demand Curve Elasticity Along A Straight Demand Curve
A
$25
PED = [(20 – 0)/10] / [(15 – 25) /20] =
Price

PED
$20
• At prices above mid-point
____________
B PED =[(30 –20)/25]/[(10 – 15)/12.5]
$15
• At mid-point price
____________

$12.5
• At prices below mid-point
____________ C PED =[(50–30)/40]/[(0–10)/5]
$10 =

$5
• As prices fall, the demand becomes ______ elastic along a straight
D
demand curve
10 20 25 30 40 50
Quantity

Tutorial Question (PED)

Market Equilibrium
Q1 When the fruit stall increase its price from $1.00 to $1.20 per piece of fruits, the numbers of fruit sold falls from 200 to 180 pieces per day.
Calculate the price elasticity of demand of the fruit stall and interpret the result.

Q2 Patrina runs a small noodles staff in a coffee shop. She tells her fishball supplier that she will only pay $3 per kg of fishball and not a cent
more. Based on this information, what can you conclude about Patrina’s elasticity of demand for fishball?
(A) Elastic
(B) Perfectly elastic
(C) Inelastic
(D) Perfectly inelastic
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 Microeconomics Lecture Gap Sheets - way
Part 2 – Total Revenue and Elasticity
Elastic Demand
• When price increases, does total revenue increase or decrease ? (PED > 1)
Change in quantity Change in price
• If you want to increase revenue, do you increase or reduce price ?

Depends on the __________________________
P

2.1 Elastic Demand PED > 1

• When price reduce, quantity demanded increase by a _______ amount

• % change in quantity % change in price
• Therefore, total revenue = P x Q = total revenue ___________
Quantity
•
__________ relationship between price and total revenue
Inelastic Demand
(PED < 1)
2.2 Inelastic Demand PED < 1 Change in quantity Change in price

• When price reduce, quantity demanded increase by a ________ amount P

• % change in quantity % change in price

• Therefore, total revenue = P x Q = total revenue ___________

•
_________ relationship between price and total revenue

Quantity
2.3 Unit Elastic Demand PED = 1
. Elastic Demand
Unit
• When price reduce, quantity demanded increase by _________ amount Price
• % change in quantity % change in price
• Therefore, total revenue = P x Q = total revenue ____________
PED = 1
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 Microeconomics Lecture Gap Sheets - way

2.4 Total Revenue Test

• How to determine PED if PED is unknown ?
Do total revenue test

• When price reduce and total revenue increase
__________ demand (_________ relationship between price and TR)
• When price increase and total revenue reduce
__________ demand

• When price reduce and total revenue reduce
__________ demand (__________ relationship between price and TR)
• When price increase and total revenue increase
__________ demand

• When price changes and total revenue do not change
_______________ demand

2.5 Total Revenue for a Straight Line Demand Curve

Total Revenue Along A Straight Line Demand Curve

P Elastic > 1

Unit Elastic = 1

Inelastic < 1

Q
Total
Revenue

As price falls, As price falls,

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Q
 Microeconomics Lecture Gap Sheets - way
Tutorial Question (PED & TR)
Market Equilibrium
Q3 If PED is - 2. To increase TR, do you increase or reduce price ?

PED > 1
__________ demand
%change in qty _____ % change in price

So for a certain reduction in price
% change in qty is ___________
TR __________

Q4 IF PED is – 0.2. To increase TR, do you increase or reduce price ?

PED < 1
___________ demand
% change in qty ____ % change in price

So for a certain increase in price
% change in qty is __________
TR ____________

Past Exam Question

Q5 A local pizzeria charges $10 for a pizza. The owner of the pizzeria wants to increase the company's total revenue. A recent
market research shows that the price elasticity of demand for his pizza is about 1.5. Should the pizzeria lower or raise the
price? Explain your answer.

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 Breadfast food
Microeconomics Lecture Gap Sheets

Many-substitutes
way
Part 3 – Factors that affects Price Elasticity of Demand Petrol

Few substitutes

3.1 Closeness of Substitutes (Availability of Substitutes)

a) Few vs many substitutes

• Few substitutes
_____________ demand (Petrol
few substitutes)
• Many substitutes
_____________ demand (Breakfast
many substitutes)

b) Necessities vs Luxury Rice

Necessity
Branded Bags

Luxury

• Necessities
_____________ demand (rice)

• Luxury
_____________ demand (branded goods
– nice to have)

3.2 Proportion of Income Spend on Good

• Small % of income spend on good
_______________ demand (table salt)

• Big % of income spend on good
_______________ demand (big ticket items)

3.3 Time Elapsed (consumers takes time to adjust)

• Short time elapsed
_______________ demand (petrol price rise) Time Elapsed
• Long time elapsed
_______________ demand

Now 6 Months Later 12 Months Later 18 Months Later

Still drive Drive Less Change to Smaller Car Sell Car

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 Microeconomics Lecture Gap Sheets - way

Part 4 – Cross Elasticity of Demand (CED) & Income Elasticity of Demand (YED)

• Besides price, demand of a good also depends on 1) Prices of substitutes There is also a responsiveness
2) Prices of complement to a change of these variables
3) Income level

• Cross Elasticity of Demand
measure the responsiveness of demand to a change in the price of a substitute or complement
CED (substitutes)
CED (complements)

• Income Elasticity of Demand
measure the responsiveness of demand to a change in income

YED

4.1 Income Elasticity of Demand

Income elasticity of demand (YED) = % change in quantity demanded

% change in income

a) Normal and luxury good income increase
buy _________ Income elasticity of demand _______

b) Normal and necessity good income increase
buy _________ Income elasticity of demand _______

c) Inferior good income increase
buy _________ Income elasticity of demand _______

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 Microeconomics Lecture Gap Sheets - way

4.2 Cross Elasticity of Demand for a Substitute (burger and pizza are substitutes)
Cross Elasticity of Demand for Substitute
Price (Burger) rise
_______________________________ Burger and Pizza

_______________________________ Movement along Shift in demand curve
demand curve for burger for pizza
P P
Cross Elasticity of demand for substitute, CED
P2

% change in quantity demanded

P1
= % change in price of substitute
D1
D1

= = Q2 Q1 Q Q

Demand curve for burger Demand curves for pizza

4.3 Cross Elasticity of Demand for a Complement (xbox and xbox games)
Cross Elasticity of Demand for Complement
Price (xbox) rise
______________________________ xbox and xbox games

______________________________
Movement along Shift in demand curve
demand curve for xbox for xbox game
Cross Elasticity of demand for complement, CED P P

% change in quantity demanded P2

= % change in price of complement

P1

D1 D1
D2
= =
Q2 Q1 Q Q

Demand curve for xbox Demand curves for xbox games

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 Microeconomics Lecture Gap Sheets - way

Part 5 – Price Elasticity of Supply

5.1 Different Types of Price Elasticity of Supply

Change in quantity supplied x 100% Qnew – Qinitial x 100%

PES = % change in quantity supplied = Average quantity supplied = (Qnew + Qinitial) /2
% change in price Change in price x 100% Pnew – Pinitial x 100%
Average price (Pnew + PInitial) /2

Measure the responsiveness in the change in quantity supplied to a change in price.

Elastic Supply PES > 1 Unit Elastic Supply PES = 1

Inelastic Supply PES < 1

Price PES = 20% / 10% = 2 Price

Price PES = 5% / 10% = 0.5
PES = 1

10% 10% Steeper slope – change in

quantity supplied is less
responsive to a change in price
Flatter slope - Change in quantity
supplied is more responsive to a
change in price

Quantity Quantity
20% 5% Quantity

Perfectly Elastic Supply Perfectly Inelastic Supply

Price Price

PES = 0
PES = α (infinity)

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Quantity
 Microeconomics Lecture Gap Sheets - way

5.2 Factors That Affect Elasticity of Supply

1 Resources Substitution Possibilities

• Easier to substitute resources
More ______________ supply

• Difficult to substitute resources
More ______________ supply

2 Supply Time Frame

• Longer the time
More _____________ is the supply

Momentary Supply Short-run Supply Long-run Supply

Price Price Price

Quantity Quantity Quantity

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 Revision Question 3 Microeconomics Lecture Gap Sheets - way

Consider a product X with price elasticity of demand equals -3.2, income elasticity of demand equals 2.6 and cross elasticity of demand with product Y
equals 1.8. What happen to the revenue of the firm selling product X when

(i) it increases the price of X,

(ii) a major recession occurs and
(iii) seller of product Y reduces the price of product Y?

Analyze each case separately.

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 Microeconomics Lecture Gap Sheets - way
Additional Tutorial Questions

Q6 An instant noodle manufacturer observes that when the mean income of his consumers is $2000 per month, he can sell 5000
packets of instant noodle per day. But with economic growth and average income of his consumers increase to $2500, he can sell
4500 packets of instant noodle. Calculate the income elasticity of demand of the instant noodle. What will happen to his revenue
when the economy enters a recession?

• The income elasticity of demand is (-500/4750) /(500/2250) = -0.474.

(have taken a short cut above. please use the final and initial numbers to arrive at the above numbers)

• Since the income elasticity of demand is negative, instant noodle is an inferior good.
• During recession, income falls. Demand for inferior good, instant noodles will rise. Therefore the instant noodles seller will be
able to earn higher revenue when the economy enters a recession.

Q7 A seller of a product Z discovered that when the price of another product W is $5 per unit, he can sell 750 units of Z. When the
price of W increases to $6.50, he can sell 580 units of Z. Calculate the cross elasticity of demand between Z and W. What will
happen to his revenue when price of W decreases?

• The cross elasticity of demand between Z and W is (-170/665)/(1.5/5.75) = -0.98.

(have taken a short cut above. please use the final and initial numbers to arrive at the above numbers)

• Since the cross elasticity of demand between Z and W is negative, Z and W are complements.
• When the price of W decreases, the revenue from selling Z will increase

Q8 Given that a product X has income elasticity of demand equals -2.5, its cross elasticity with another product W is -1.8, and its
price elasticity of supply is 2.6, what can you comment about the nature of this product?

• The product X is an inferior good since the income elasticity of demand is negative
• The product X is a complement to the product W since the cross elasticity of demand is negative
• The product X is price elastic in supply since the price elasticity of supply is greater than 1
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 Past Exam Questions Microeconomics Lecture Gap Sheets - way

Q9 Evaluate whether the following statements regarding elasticity are true or false. Justify your answers.
(i) Consider two goods, A and B, with income elasticity of demand – 2.5 and 0.8 respectively. During a recession where
consumers’ income generally decreases, sellers of A will earn higher revenue while sellers B will earn lower revenue.

(ii) Given that the cross elasticity of demand between X and Y is -1.8 and the cross elasticity of demand between X and Z is 0.4,
when the price of X increases, sellers of Y will earn higher revenue while sellers of Z will earn lower revenue.

(i) A : YED negative
Inferior good ( Recession
Income fall) Demand for inferior good, A rises
sellers of good A earn higher revenue
B : YED positive
Normal good ( Recession
Income fall) Demand for normal good, B fall
sellers of good B earn lower revenue
Therefore, statement is true.

(ii) False
CED (X, Y) negative
X and Y are complements
CED (X, Z) positive
X and Z are substitutes
Price of X rise
Qty demanded (x) fall (law of demand)
demand for Y falls (X and Y are complements)
sellers of Y earn lower revenue

demand for Z rise (X and Z are substitutes)
sellers of Z earn high revenue
Therefore, statement is false.

Q10 During a recession when people's incomes drop, supermarkets experience much smaller declines in sales than do upscale
department stores. Explain this phenomenon using the concept of income elasticity.

During a recession, people's income decreases leading to a decrease in the quantity of normal goods they buy.
The demand for necessities is less income elastic, that is, less responsive to a change in income, than the demand for luxuries.
So supermarkets, which sell mainly necessities, lose fewer sales than do upscale department stores, which sell luxury items.

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 Powerpoint Tutorial Questions Microeconomics Lecture Gap Sheets - way

1 When demand is price elastic, an increase in price will cause _________________.

(A) an increase in total revenue.
(B) a decrease in total revenue.
(C) no change in total revenue, but an increase in quantity demanded.
(D) no change in total revenue, but a decrease in quantity demanded.

2 Staple products such as rice, is a necessity for Asians, It is likely that demand ________.
(A) Will be inelastic. (B) Will be elastic. (C) has unit elasticity. (D) cannot be represented by a demand curve in the usual way.

3 Which of the following represents a price elastic supply?

(A) The quantity demanded increases 18 percent as a result of a decrease in the price of 8 percent.
(B) The price rises by 8 percent causing the quantity demanded to fall by 10 percent.
(C) The quantity supplied increases by 21 percent as a result of an increase in the price of 12 percent.
(D) The price rises by 22 percent causing the quantity supplied to increase by 3 percent.

4 When a supplier reduces the price of its products, and as a result, there is an increased in revenue. The product is likely to _____.
(A) Be a luxury good. (B) Be a necessity. (C) Have an inelastic demand curve. (D) Have an elastic demand curve.

5 The price of a COE is a major consideration for any prospective car-owner. (Depending on when you buy a car, the price of a COE may be even more expensive
than the price of your car.) In 2013, when the COE price was $22,000, there were 75000 cars sold. However, when the COE price was $87,000, there were about
50,000 cars sold.

a. Using the midpoint method, calculate the Price Elasticity of Demand (PED). Explain your answer briefly.

b. From your answer in part (i) answer discuss what would happen to total revenue if major car distributors were to increase the price of cars? Provide an
illustration to support your discussion.

6 With Uber exiting from the Singapore market, the market space is now filled by Grab and new competitors such as Ryde. It was reported that when the median
price of a Grab ride is $3, a Ryde driver could make 10 trips a day. However, if the median price of a Grab ride increases to $5, the Ryde driver could make 16
trips a day. Compute the Cross Elasticity of Demand (CED). Explain your answer briefly

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 Microeconomics Lecture Gap Sheets - way
Lecture 4 Summary

Price Elasticity of Demand

Total Revenue and Elasticity
Change in quantity x 100% Qnew – Qinitial x 100%
PED = % change in quantity demanded = Average quantity demanded = (Qnew + Qinitial) /2 Factors that Affect Price Elasticity of Demand
% change in price Change in price x 100% Pnew – Pinitial x 100% Elastic Demand Ed > 1
Average price (Pnew + PInitial) /2

Inelastic Demand
Factor Demand is Demand is Inverse relationship between price and total revenue.
Elastic Demand

Price
PED > 1 Price PED < 1 Price
. Elastic Demand
Unit
relatively relatively - Price
Total Revenue
B
Flatter slope
B elastic if inelastic if - Price
Total Revenue
10% PED = 1
10% Steeper Slope
A A
Availability Many substitutes Few substitutes
Of substitutes Inelastic Demand Ed < 1
20% Quantity Quantity
Quantity
Direct relationship between price and total revenue
2%
Types of Good Luxury goods Necessity goods - Price
Total Revenue
Perfectly Elastic Demand
.
Perfectly Inelastic Demand
- Price
Total Revenue
Price
Price
.
Passage of A long time passes A short time passes
PED = ______ = α (infinity)
0
PED = _ 0__ = 0 Time
Horizontal Demand Curve Unit Elastic Demand Ed =1
Vertical Demand Curve Fraction of Large Small Total revenue does not vary with price
Quantity demanded is extremely w
responsive to changes in price Quantity demanded is completely
unresponsive to changes in price
Consumer Budget
Quantity
Quantity

Elasticity of Supply Factors That Affect Supply

Income and Cross-Price Elasticities Elasticity of supply depends
Elastic Supply

Price
PES > 1 Inelastic Supply Unit Elastic Supply
PES = 1
1. Resource substitution possibility
PES < 1
Price Price
• Easier to substitute resources
More elastic
10%
10% Steeper
Flatter slope
2. Supply decision time frame
20%
Quantity
Quantity
• Greater the time
More elastic
Quantity
5%
– Momentary supply
Perfectly inelastic
Perfectly Elastic Supply Perfectly Inelastic Supply – Short run supply
Somewhat elastic
PES = 0
PES = α (infinity)
Price Price
– Long run supply
Elastic
Income elasticity > 1 Normal good and is a luxury Long-run Supply
Short-run Supply
Income elasticity < 1 Normal good and is a necessity Momentary Supply
Price
Price
Price

PES = 0

Perfectly inelastic supply

Somewhat elastic
Quantity Quantity Most elastic
PES < 1
PES > 1

Quantity
Quantity Quantity

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