Elasticity & case studies

1- Price elasticity of demand

 1- What is Ed?
 2- How to calculate Ed?
 3- Different values of Ed & shapes of
Demand curves.
 4- Relation between changes in price,
changes in revenues & Ed.
 5- What determines Ed?
What is Ed?
It is a measure that shows how the %
change in quantity demanded of a product
RESPONDS to the % change in the price of
the product itself, other factors being
constant.
How to measure Ed?
 Ed= % change in Qdx / % change in Px
 Ed=change in Q/change in P . P/Q
 Example: If the quantity demanded of a
certain product increased by 80% when its
price fell by 20%, calculate Ed. What does
the value show?
 Ed=+80%/-20%= -4(every 1% change in
P yields 4% in Q , in the inverse direction)
Another example
 Calculate Ed from the following table using the
point elasticity of demand, the original situation
was ( A):
 P Q
 A)100 100
 B)90 140
 Ed= 40/-10 . 100/100=-4( notice that addressing
the absolute value, Ed is more than unity, ie %
change in Q RESPONDS GREATLY to % change in
P.
3-Different values of Ed & shapes of
demand curves
 1-Ed might be Zero.Demand is PERFECTLY
INELASTIC
 Meaning: Qd does not respond whatsoever to P
changes. The Qd remains constant , regardless of
price changes.
 Example: Vital necessities with no substitutes.
 Demand curve is vertical as seen in the following
diagram:
Shape of PERFECTLY INELASTIC
Demand curve:
It is vertical:
2-Ed= infinity
 Demand for the product is perfectly elastic.
 Meaning: consumers are ready to buy an infinite
quantity at a certain price & none at all at a
slightly higher price.
 Example: Very luxurious products with endless
number of substitutes( the product is not
important whatsoever for the consumer
 Demand curve will be horizontal as follows:
Shape of a perfectly elastic demand
curve.
 It is horizontal:
3-Ed=1
 Demand is of unit elasticity.
 Meaning:% change in Qd =% change in P
 Demand curve takes shape of a
rectangular hyperbola( area under the
curve which reflects REVENUE is always
constant) as follows:
A demand curve of unit elasticity
 Revenues are always constant under the
curve:
4- Ed is more than unity(Demand is
elastic)
 Meaning: % change in Q exceeds % change in P
 Example: when price rises by 10%, Quantity falls
& responds greatly , by 50%( Ed =- 5, as an
absolute value Ed is more than 1.
 It is the case of a product that has many
substitutes & is not important to the consumer.
 Demand curve is relatively flat( versus the
following fifth last case). The diagram is as
follows:
A relatively elastic demand curve
5-Ed is less than unity.
Demand is inelastic
 Meaning: % change in Q is less than the %
change in P.
 Example: When price rises by 10%, Quantity
demanded falls slightly by 2%. Thus the value of
Ed is - 0.5 ( less than one, as an absolute value).
 Real case study: it might be a necessary product
to the consumer, & it had few substitutes. The
demand curve will be relatively steep versus the
previous case.
Demand curve that is relatively
inelastic:
5- Relation between changes in price,
changes in revenues & Ed.
 Definitely total revenue is just equal to total
spending ( P . Q)
 If demand for the product is elastic( eg. When
price falls by 10%, quantity demanded increases
greatly , by 50% for instance, thus offsetting the
decrease in price & total revenue increases. Thus
if demand is elastic, seller should lower the price
to boost revenues.
 This can be seen from the following
diagram:
 If demand for the product is inelastic ( eg
when price rises by 20% , quantity
demanded falls slightly by 5% , for
instance, thus price change offsets
quantity change & total revenues increase.
 Thus, if demand is inelastic it is for the
benefit of the seller to increase the price
to receive more of a revenue.
 The following diagram shows the previous
case;
 If demand for the product is of unit
elasticity( eg. A fall in price by 10% is
offset by an increase in quantity by 10%,
thus leaving revenues constant.) This can
be seen in the following diagram:
 The diagram shows that the total revenue
( Or total spending from consumer’s side
is constant regardless of price changes.
5- What determines Ed?

 Main determinants are:

 The more important & necessary the product is ,
the less the elasticity .( demand is inelastic for
necessities & elastic for products that are not
important for the consumer).
 The more the number of substitutes , the more
the elasticity( the demand is elastic for a product
with many substitutes & inelastic in case of few
substitutes).
 The longer the time period , the more the
elasticity.
Cases to comment on:
 1- TWA company was seeking to maximize
revenues. Top managers advised the company to
increase the prices of the VIP class & to decrease
the prices of the economy class on the same
flight.
 2-Directly after the October War in 1973, many
Arab countries were able to maximize petroleum
revenues as the price per barrel increased by 4
fold. However, afterwards, the foreign importing
 countries set strategies to confront the
unfavorable supply shock.
 3- The prices of some goods seem to
fluctuate more than others as a result of a
decrease in supply, prove that the price
elasticity of demand is behind such price
fluctuations.
 HINT : the less the elasticity the more the
price fluctuations.
Price Elasticity of Supply
 1- What is Es?
 2- How to measure Es?
 3- different values of Es & shapes of
Supply curves.
 4- what determines Es?
1-What is Es?
 Es is a measure that shows how % change
in quantity supplied of the product
RESPONDS to the % change in the price of
the product, other factors being constant.
2-How to measure Es?

 Es= % change in Qs/ % change in price.

 Es= change in Qs/change in P . P/Q
 Eg. Calculate Es if you know that the
quantity supplied of a product increased
by 40% when its price increased by 10%.
 Answer: Es = =40%/=10%=4( every 1%
change in price yields 4% changes in
qs( in the same direction)
Calculate Es from the following table
using point elasticity of supply
 Assume that A) is the original situation:
 P Qs
 A) 10 100
 B) 60 900
 Es= 800/50.10/100= 1.6( more than 1,
thus supply is elastic)
3- Different values of Es & shapes of
Supply curves
 1- Es= zero ( Supply is perfectly
inelastic)
 Meaning: Qs is constant regardless of
price changes , eg. Crop with no
inventories in the very short run.
 Supply curve is vertical as following:
 Supply curve that is
perfectly inelastic:
2- Es= infinity( supply is perfectly
elastic)
 Meaning EG. Suppliers supply all they can
at a certain price & none at a slightly
lower price.
 Supply curve is horizontal as following:
3-Es=1 ( supply is of unit elasticity)
 Meaning :% change in Qs=% change in P
 Supply curve originates from the origin
( or its extension starts from the origin)
as:
4- ES is more than 1( supply is elastic)
 Meaning :% change in Qs exceeds %
change in P. The supply curve is relatively
flat versus the coming last case, it
intersects the horizontal axis) as:
5- Es is less than 1( supply is inelastic)
 Meaning: % change in Qs is less than %
change in P. Supplier CANNOT respond
GREATLY to the price signals. Supply
curve is relatively steep versus the
previous case , it intersects the horizontal
axis as:
4- what determines Es?
 1- The more
efficient &
sufficient the
resources are
the more the
elasticity.
 2- The longer
the period of
time, elasticity
usually
increases