ECONOMICS 1A

Lecturer : Meshel Muzuva

29 April 2023
Webinar Recap: Government Intervention
Maximum prices
❖ A price ceiling occurs when
the government puts a legal
upper limit on the price that
can be charged for a good or
service.
❖ If the government sets a
maximum price of Pm below
the equilibrium price of P0

❖ This results in an excess

demand of Q2 – Q1 (or ab).
nimum prices (price floors)

A price floor means that

the government puts a
legal lower limit or
minimum price that can
be charged for a good or
service
The welfare costs of minimum price fixing
Activity 1

Which of the following is correct with regard to maximum prices?

[I]: It will only have an impact on market price and quantity exchange if it
is set below the equilibrium price.
[II]: It would never stimulate black market activities.
[III]: If it is set below the equilibrium price, it results in excess demand.
a) [I] and [II] only
b) [I] and [III] only
c) [II] and [III] only
d) [I], [II] and [III]
Activity 2

If the minimum wage is set above the current

equilibrium market wage…
there will be an excess demand for labour at the
a) minimum wage.
b) it will have no effect on the quantity of labour
employed.
c) the unemployment rate will rise.
d) the unemployment rate will fall.
UNIT 6 ELASTICITY
LECTURE OUTLINE

❖ Define elasticity
❖ Explain the meaning and significance of price elasticity of
demand
❖ Distinguish between five categories of price elasticity of
demand
❖ Define income elasticity and cross elasticity of demand
Introduction

We have analysed the direction of change

when demand or supply changes. Now
let’s analyse the size of those changes.

By how much will price and quantity change if

demand or supply changes?
How will a change in the price of a good or service
affect the total amount that consumers plan to
spend on that particular good or service?
UNIT 6: ELASTICITY

➢Elasticity is the measure of the responsiveness of a dependent variable to changes in

an independent variable

➢The price elasticity of demand is a measure of the sensitivity of quantity demanded to

changes in price.

Price Elasticity of Demand (Ep) = % change in quantity demanded

% change in price

➢ Total revenue (or expenditure): The price (P) of a good or service multiplied by the
quantity (Q) of that good or service sold. TR = PQ.
PRICE ELASTICITY
As a general rule, we can state the following:
❖ If the percentage change in price is greater than the percentage change in quantity demanded, then
the price elasticity coefficient is less than 1. This applies to things such as salt, medical services, fuel,
beer and so forth. In these cases consumers are less responsive or sensitive to a change in the price.

❖ If the percentage change in price is smaller than the percentage change in quantity demanded, then
the price elasticity coefficient is greater than 1. This applies to things such as private education,
restaurant meals and fresh tomatoes. In these cases consumers are more responsive or sensitive to a
change in price.
RELATIONSHIP BETWEEN PRICE ELASTICITY OF DEMAND AND TOTAL REVENUE

❖ When ep is greater than one, total

revenue increases as the quantity of
cappuccinos increases.

❖ When ep is equal to one, total

revenue is at a maximum.

❖ When ep is less than one, total

revenue falls as the quantity of
cappuccinos increases.
Categories of the Price Elasticity of Demand

There are five categories of Price elasticity of demand:

Categories of the Price Elasticity of Demand

Perfectly inelastic demand (ep = 0), consumers will plan to purchase a fixed amount of the product
regardless of the price which is charged. In this case, producers can raise their revenue by increasing
the price charged for the product. As the quantity demanded does not change, raising price results in an
increase in total revenue. Remember TR = PQ.
Categories of the Price Elasticity of Demand

Inelastic demand (0 < ep < 1), the percentage change in quantity demanded is smaller than the percentage change
in price. Producers have an incentive to raise their prices in order to increase their revenue. Likewise, there is no
reason why producers would decrease the price of their product as the revenue received from the increase in
quantity demanded will not offset the revenue lost due to the decrease in price.
Categories of the Price Elasticity of Demand

Unitary elasticity (ep = 1), The percentage change in quantity demand is equal to percentage change in the price of
the product. Thus, producers would not gain anything by increasing or decreasing the price of the product.
Categories of the Price Elasticity of Demand
Elastic demand (1 < ep < ∞), The percentage change of quantity demanded is greater than the percentage change in price. When
producers are faced with elastic demand, decreasing the price of the product will raise the total revenue received by producers
(this is as a result of the property of elastic demand, also remember TR = PQ). There is no incentive to raise the price charges for
the product as this would decrease total revue (the opposite of decreasing the price will occur).
Categories of the Price Elasticity of Demand

Perfectly elastic demand (ep = ∞) Consumers are willing to purchase any quantity of goods at a certain price, raising
the price of the good will result in the quantity demanded falling to zero (even if the price is only raised slightly).
Price elasticity of demand: a summary
Activity 1

1. If the % change in P is greater than the % change in Qd, then demand is …

a) inelastic.
b) elastic.
c) unitary elastic

2. If an 8% change in price leads to a 12% change in Qd, the demand is

a) inelastic
b) elastic
c) unitary elastic
Activity 2

You are given the following diagrams (a and B) and must indicate whether the demand is
relatively elastic, relatively inelastic or unitary elastic.

Figure a figure b
Income elasticity of demand
A measure of the responsiveness of the quantity demanded of a good to
changes in consumer income, ceteris paribus

% change in quantity demanded

% change in income
Income elasticity of demand

Q↑ Q↓

Income ↑ Income ↓

Q↓ Q↑
Normal good
(0 < ey)
Income ↑ Income ↓

Inferior good Essential good Luxury good

(ey < 0) (0 < ey < 1) (1 < ey < ∞)

-∞ 0 1 ∞
The cross elasticity of demand
The responsiveness of the quantity demanded of a particular good to changes in the
price of a related good

% change in demand for product A

% change in price of product B

Positive sign: substitutes

When the price of one increases, the quantity demanded of the other
increases.

Negative sign: complements

When the price of one increases, the quantity demanded of the other
decreases.
The cross elasticity of demand

Q↓ Q↑ Q↑ Q↓

Price of Price of Price of Price of

related related related related
good ↑ good ↓ good ↑ good ↓

Complements Substitutes
(ec < 0) (0 < ec)

-∞ 0 ∞
Activity 3
You have the following information:

Price (P) Quantity demanded (Qd)

8 100
10 90

If the price increases from R8 to R10, what is the price elasticity of demand?

The increase in price is R2, and the percentage increase in price is R2/R8 x 100 = 25%.
The quantity demanded decreases by 10 units (100 – 90), and the percentage decrease in the quantity
demand is 10 units/100 units x 100= 10%.
Activity 4

1. Suppose the cross-elasticity of demand between two products, A and B, is negative. If the
price of product A increases as a result of a decrease in the number of firms supplying the
product, the quantity demanded will _____.
a. increase for both products A and B
b. fall for both products A and B
c. increase for product A and fall for product B
d. fall for product A and increase for product B

2. Suppose the cross-elasticity of demand between two products, A and B, is positive. If

there is a fall in the cost of producing good B, the quantity demanded will _____.
a. increase for both goods
b. decrease for both goods
c. increase for good A and decrease for good B
d. decrease for good A and increase for good B
THANK YOU