ECO-101 Micro Economic Lecture

1. Elasticity of Supply
Micro Economics

2. Elasticity of Supply
A measure of the responsiveness of the
quantity supplied to a price change.
The elasticity of supply measures the
responsiveness of the quantity supplied to a
change in the price of a good when all other
influences on selling plans remain the
same.

3. Elasticity of Supply
Calculating the Elasticity of Supply
formula:
 Percentage change in quantity
supplied
 Percentage change in price

4. Price Elasticity of Demand
 Total Revenue and Elasticity
 The total revenue from the sale of good or
service equals the price of the good multiplied
by the quantity sold. (P x Q)
 When the price changes, total revenue also
changes.
 But a rise in price doesn’t always increase
total revenue.

5. Price Elasticity of Demand
The change in total revenue due to a change in
price depends on the elasticity of demand:
 If demand is e lastic, a 1 percent price cut
increases the quantity sold by more than 1
percent, and total revenue increases.
 If demand is ine lastic, a 1 percent price cut
decreases the quantity sold by more than 1
percent, and total revenues decreases.
 If demand is unit e lastic, a 1 percent price cut
increases the quantity sold by 1 percent, and total
revenue remains unchanged.

6. Price Elasticity of Demand
The total revenue test is a method of estimating the
price elasticity of demand by observing the change in
total revenue that results from a price change (when
all other influences on the quantity sold remain the
same).
 If a price cut increases total revenue, demand is
elastic.
 If a price cut decreases total revenue, demand is
inelastic.
 If a price cut leaves total revenue unchanged,
demand is unit elastic.

7. Price Elasticity of Demand
Your Expenditure and Your Elasticity
 If your demand is elastic, a 1 percent price cut
increases the quantity you buy by more than 1
percent and your expenditure on the item
increases.
 If your demand is inelastic, a 1 percent price cut
increases the quantity you buy by less than 1
percent and your expenditure on the item
decreases.
 If your demand is unit elastic, a 1 percent price cut
increases the quantity you buy by 1 percent and
your expenditure on the item does not change.

8. Price Elasticity of Demand
The Factors That Influence the Elasticity of
Demand
 The elasticity of demand for a good depends
on:
The closeness of substitutes
The proportion of income spent on the good
The time elapsed since a price change

9. Price Elasticity of Demand
 Closeness of Substitutes
 The closer the substitutes for a good or
service, the more elastic are the demand
for it.
 Necessities, such as food or housing,
generally have inelastic demand.
 Luxuries, such as exotic vacations, generally
have elastic demand.

10. Price Elasticity of Demand
 Proportion of Income Spent on the Good
 The greater the proportion of income consumers
spent on a good, the larger is its elasticity of
demand.
 Time Elapsed Since Price Change
 The more time consumers have to adjust to a
price change, or the longer that a good can be
stored without losing its value, the more elastic is
the demand for that good.

11. More Elasticities of Demand
 Cross Elasticity of Demand
 The cross elasticity of demand is a
measure of the responsiveness of demand
for a good to a change in the price of a
substitute or a co m ple m e nt, other things
remaining the same.
 The formula for calculating the cross
elasticity is:
Percentage change in quantity demanded
Percentage change in price of substitute or
complement

12.  Independent Goods
A Zero or near Zero cross elasticity suggests
that the two products are unrelated or
independent goods.
Example: We would not expect a change in the
price of butter to have any impact on the
purchases of film.

13. Elasticity of Supply
 Calculating the Elasticity of Supply
 The elasticity of supply is calculated by
using the formula:
Percentage change in quantity supplied
Percentage change in price

14. Calculate elasticity of Supply
Price per bunch
of five daffodils
Qs supplied per
month
$1 10000
$2 12000

15. answer
 Es= 0.2

16. Do the calculation
 Here is supply
schedules for natural
rubber and man made
rubber
 Calculate price elasticity
of supply for natural
rubber and man made
rubber
Price per lb Qs of
natural
rubber per
month
$0.80p 1000
$1.00 1100
Price per lb Qs of man
made
rubber per
month
$0.80p 2000
$1.00 2800

17. Elasticity of Supply

18. Elasticity and Total Revenue
When demand is inelastic, price and total revenues are
directlyrelated. Price increases generate higher revenues.
When demand is elastic, price and total revenues are
indirectlyrelated. Price increases generate lower revenues.
Type of
demand Value of Ed
Change in quantity
versus change in price
Effect of an
increase in
price on total
revenue
Effect of a
decrease in price
on total revenue
Elastic Greater than
1.0
Larger percentage change in
quantity
Total revenue
decreases
Total revenue increases
Inelastic Less than 1.0 Smaller percentage change
in quantity
Total revenue
increases
Total revenue
decreases
Unitary
elastic
Equal to 1.0 Same percentage change in
quantity and price
Total revenue does
not change
Total revenue does not
change
T R P Q= ×

19. Elasticity
Price
Quantity Demanded (000s)
D
The importance of elasticity
is the information it
provides on the effect on
total revenue of changes in
price.
£5
100
Total revenue is price
x quantity sold. In
this example, TR =
£5 x 100,000 =
£500,000.
This value is
represented by the
grey shaded
rectangle.
Total Revenue

20. Elasticity
Price
Quantity Demanded (000s)
D
If the firm decides to
decrease price to (say) £3,
the degree of price elasticity
of the demand curve would
determine the extent of the
increase in demand and the
change therefore in total
revenue.
£5
100
£3
140
Total Revenue

21. Elasticity
Price (£)
Quantity Demanded
10
D
5
5
6
% Δ Price = -50%
% Δ Quantity Demanded = +20%
Ped = -0.4 (Inelastic)
Total Revenue would fall
Producer decides to lower price to attract sales
Not a good move!

22. Elasticity
Price (£)
Quantity Demanded
D
10
5 20
Producer decides to reduce price to increase sales
7
% Δ in Price = - 30%
% Δ in Demand = + 300%
Ped = - 10 (Elastic)
Total Revenue rises
Good Move!

23. Elasticity
 If demand is price
elastic:
 Increasing price would
reduce TR (%Δ Qd > %
Δ P)
 Reducing price would
increase TR
(%Δ Qd > % Δ P)
 If demand is price
inelastic:
 Increasing price would
increase TR
(%Δ Qd < % Δ P)
 Reducing price would
reduce TR (%Δ Qd < %
Δ P)

24. Elasticity
 Income Elasticity of Demand:
 A positive sign denotes a normal good
 A negative sign denotes an inferior good

25. Elasticity
 For example:
 Yed = - 0.6: Good is an inferiorgood but inelastic – a rise in income of 3%
would lead to demand falling
by 1.8%
 Yed = + 0.4: Good is a normal good but inelastic –
a rise in incomes of 3% would lead to demand rising
by 1.2%
 Yed = + 1.6: Good is a normal good and elastic –
a rise in incomes of 3% would lead to demand rising
by 4.8%
 Yed = - 2.1: Good is an inferiorgood and elastic –
a rise in incomes of 3% would lead to a fall in demand of 6.3%

26. How will the following changes in price affect total
revenue _TR increases, decreases or remains
unchanged.
a. Price falls and demand is inelastic
b. Price rises and demand is elastic
c. Price rises and supply is elastic
d. Price rises and supply is inelastic
e. Price rises and demand is inelastic
f. Price falls and demand is elastic
g. Price falls and demand is of unit elasticity

27. Answers; TR will
a. decreases
b. decreases
c. Increases
d. Increases
e. Increases
f. Increases
g. remains same

28. What are the major determinants of price
elasticity of demand?
Use these determinants in judging whether
demand for each of the following products is
elastics or inelastic:
a) Oranges
b) Cigarettes
c) Winston cigarettes
d) Gasoline
e) Butter
f) Salt

29. g. Automobiles
h. Football games
i. Diamond bracelet
j. This text book

30. Answers!
a. elastic
b. inelastic
c. elastic
d. inelastic
e. elastic
f. inelastic
g. elastic
h. elastic
i. elastic
j. inelastic