Managerial economics demand and supply

Elasticity
• Elasticity: A measure of the responsiveness of

one variable to changes in another variable; the
percentage change in one variable that arises
due to a given percentage change in another
variable.
• By converting each of these changes into
percentages, the elasticity measure does not
depend on the units in which we measure the
variables.
• Refers to the tecnique of measuring the degree
of responsiveness of quantity demanded due to
change in a specific factor that affects demand
Own Price Elasticity of Demand
• Own price elasticity: A measure of the
responsiveness of the quantity demanded of a good
to a change in the price of that good; the
percentage change in quantity demanded divided
by the percentage change in the price of the good.
• Elastic demand: Demand is elastic if the absolute

value of the own price elasticity is greater than 1.
Price elasticity
 Measures the extent to which demand for a

product changes due to change in its price.
If there is a small change in quantity
demanded following a change in price, then
demand is said to be price inelastic
Demand is said to be price elastic if there is a
large change in demand due to a price change
ELASTICITY
Sensitivity of the quantity demanded to price is called:
price elasticity of demand:
% change in quantity demanded  Q / Q

EP  
% change in price P/ P
Arc Elasticity
To get the average elasticity between two
points on a demand curve we take the
average of the two end points (for both price
and quantity) and use it as the initial value:
q2-q1/(q2+q1)/2
p2-p1/(p2+p1)/2
Geometric method or point method
Es= Difference b/w Qty and intersect on X

axis Difference between Qty and
origin
Slope of the Demand Curve
• DP is the change
in price. (DP<0) Price Demand
P
slope 
Q
 DQ is the change P
in quantity. DP
P+ DP
DQ
 slope =
DP/ DQ
Q Q + DQ Quantity
Types of elasticities
• elastic: the quantity demanded changes
more than in proportion to a change in price
• inelastic: the quantity demanded changes

less than in proportion to a change in price
• Elastic demand : Demand is elastic if the
absolute value of own price elasticity is
greater than 1.
• Inelastic demand: Demand is inelastic if the
absolute value of the own price elasticity is
less than 1.
• Unitary elastic demand: Demand is unitary
elastic if the absolute value of the own price
elasticity is equal to 1.
• Perfectly elastic demand : e= infinity
• Perfectly inelastic demand : e = 0
Elasticity and slope
Price
The demand curve can be a range of
shapes each of which is associated with
a different relationship between price
and the quantity demanded.
Quantity Demanded
Linear Demand Curve:
price
E = infinity e=lower segment/upper segment
E=1
E=0
Qty
Determinants of Elasticity
• Number and closeness of substitutes –
the greater the number of substitutes,
the more elastic
• The proportion of income taken up by the product – the

smaller the proportion the more inelastic
• Price of the product- lower the price, lower the elasticity
• Luxury or Necessity - for example,

addictive drugs
• Time period – the longer the time under consideration the

more elastic a good is likely to be
Cross-Price Elasticity
• Cross-price elasticity: A measure of the
responsiveness of the demand for a good to
changes in the price of a related good; the
percentage change in the quantity demanded of
one good divided by the percentage change in
the price of a related good.
• The cross-price elasticity is positive whenever
goods are substitutes.
• The cross-price elasticity is negative whenever
goods are complements.
Cross-price elasticity of demand
how quantity of one good changes as price of another
good increases
%change in quantity demanded

%change in price of another good
Q / Q Q Po
EQ , Po  
Po / Po Po Q
We use the cross elasticity
to determine if two goods are
•complements (negative sign) or

•substitutes (positive sign).
We also check to see how

interrelated two products are.
Income elasticity of demand
% change in quantity demanded

EI 
% change in income
Q / Q Q I
 
Y / Y Y Q
Income Elasticity
• Income elasticity: A measure of the
responsiveness of the demand for a good to
changes in consumer income; the percentage
change in quantity demanded divided by the
percentage change in income.
• The income elasticity is positive whenever the
good is a normal good.
• The income elasticity is negative whenever the
good is an inferior good.
Factors affecting Income elasticity:
• Nature of the good:

• inferior goods have negative income elasticity
• Normal goods have positive income elasticity
• Luxury goods have income elasticity greater
than one
• Necessary goods have income elasticity less
than one
What can we do with the income
elasticity?
• Income elastic goods do better when
income is increasing and worse when it
is decreasing.
– So if you have a good that is income elastic,
you should be very interested in what happens
to the economy (forecasts).
Advertising Elasticity
• The own advertising elasticity of demand for
good X defines the percentage change in the
consumption of X that results from a given
percentage change in advertising spent on X.
Uses of Elasticities
• Pricing
• Managing cash flows
• Impact of changes in competitors’ prices
• Impact of economic booms and
recessions
• Impact of advertising campaigns
• And lots more!
Definition Of Price Elasticity Of supply
•The change in the quantity

supplied of a product due to a
change in its price is known
as Price elasticity of supply.
Kinds Of Price Elasticity Of supply
1) Perfectly elastic supply

2) Relatively elastic supply
3) Elasticity of supply equal to utility
4) Relatively inelastic supply
5) Perfectly inelastic supply
Let Us See Some Views On Them
Perfectly elastic supply
y
When the supply
Perfectly
P elastic for a product
supply curve changes –
R
I
S
increases or
S
C decreases even
when there is no
E change in price,
it is known as
perfect elastic
0 x
supply.
Relatively elastic supply
y
When the
P Relatively elastic proportionate
supply curve
change in
R S supply is more
I
than the
S
proportionate
C
changes in
price, it is
E
0 x
known as
suppl
y relatively elastic
supply.
Elasticity of supply equal to utility
When the
y
proportionate
S
P
change in supply
is equal to
R Elasticity of
supply proportionate
I equal to changes in price,
utility curve
it is known as
C
unitary elastic
0 suppl
x supply
E
y
Relatively inelastic supply
Y
Relatively
When the
inelastic supply proportionate
curve
P S change in
supply is less
R than the
I proportionate
changes in
C
price, it is
S X
known as
EO suppl relatively
y
inelastic supply
Perfectly inelastic supply
Y
S
When there is
P
Perfectly
inelastic
no change in
supply curve the quantity
R supplied with
I the change in
its price, it is
C
perfectly
S X
E
0 suppl inelastic
y
supply
ALL KINDS OF supply CAN BE SHOWN IN
ONE DIAGRAM AS FOLLOW
Y
S5
S2
S3 WHERE
P S1) Perfectly elastic
S4
R supply
S
I
S1 S2)Relatively elastic
supply
S3)Elasticity of supply
C
equal to utility
S4)Relatively inelastic
E
0 S5 X supply
supply S5)Perfectly inelastic
supply
Measurement Of Price Elasticity Of
supply
There are two methods like
1. Percentage method or proportionate
method
2. Geometric method or point method

1 Percentage method or proportionate method
• (Es) = % Change in Quantity Supplied

% Change in Price
• ES = ∆Q/ ∆P*P/Q
• ∆Q= change in quantity supplied.
• ∆P= change in price
• Q= initial quantity supplied.
• P= initial price of the good
Factors Affecting Price Elasticity Of
supply
• Time Factor
1. Short period - relatively less elastic
2. Long period – more elastic
. Nature of the commodity
1. Perishable goods – relatively less elastic
2. Durable goods – elastic supply
. Technique of production
1. Complex technique - inelastic
2. Simple technique – elastic
.NATURE OF INPUTS USED
1.Commonly used factors – elastic
2.Specialised factors –inelastic
. Future price expectation
1.price increase- inelastic
2. price decrease – elastic
. Natural constraint
less elastic
. Risk Taking
1.Willing to take risk- more
elastic
Practical Importance of the Concept of
Price Elasticity Of supply
• The concept is helpful in taking Business
Decisions
• Importance of the concept in formatting Tax
Policy of the government
• For determining the rewards of the Factors of
Production
• To determine the Terms of Trades Between
the Two Countries

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Elasticity

• Elasticity: A measure of the responsiveness of

• Elastic demand: Demand is elastic if the absolute

 Measures the extent to which demand for a

% change in quantity demanded  Q / Q

Es= Difference b/w Qty and intersect on X

• inelastic: the quantity demanded changes

• The proportion of income taken up by the product – the

• Price of the product- lower the price, lower the elasticity

• Luxury or Necessity - for example,

• Time period – the longer the time under consideration the

%change in quantity demanded

•complements (negative sign) or

We also check to see how

% change in quantity demanded

• Nature of the good:

•The change in the quantity

1) Perfectly elastic supply

2. Geometric method or point method

• (Es) = % Change in Quantity Supplied

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