COMPUTING FOR ELASTICITY

(PRICE ELASTICITY OF DEMAND; INCOME ELASTICITY CROSS ELASTICITY; PRICE ELASTICITY OF SUPPLY )

And its application

By : Dr. Leda C. Celis, Economics Department, CBA

Price Elasticity of Demand and Pricing Decisions

Price Elasticity (Pe) of Demand is the degree of responsivenes s of Qd to a change in Price. Price elasticity of Demand=
change in Qd %change in Qd % change in P = Average Qd Change in P

Average P
Where: =1, means unitary elastic >1, means elastic <1, means inelastic

Importance of Total Revenue In Pricing Decisions:

TR = PRICE X QUANTITY Where TR = Total Revenue; Where P = price Where Q = Quantity
Note: - In Comparing two TRs,

whichever yields a higher TR (holding other things constant), the price charged is the best price of the good, whether it is the old price or the new price.

Example 1=

% change in Qd / % change in P

Cecilia sells bangus for Php 100 and her Qd = 500. When she decides to sell it at P125, her Qd2 becomes 450. Should Cecilia sell her bangus at P100 or P125? Is Qd elastic or inelastic?

First solve for % change in Demand and % change in Price % change in P = Change in P = 125-100 = 25 0.22 Average P = 100 + 125 112.5
2

% change in Qd = Change in Qd = 450 500 = - 50 = 0.11 Average Qd 500+450 475 2

Price Elasticity of Demand

Hence, 0.05 is less than 1, therefore Qd is inelastic.

Price elasticity of Demand is expressed in Absolute Value

% change in Qd % change in P = -0.11 0.22 = -0.05 or 0.5

Decisions using Total Revenue

TR 2 is higher than TR1; hence the new TR, is better. Cecilia should sell her bangus at P 125. Hence, when Cecilia increases her price while demand is inelastic, she gets bigger total revenue. She will then maximize her profit by raising her price to P 125.
TR1

= P
= 100 500

Q
x

= 50,000.00

TR 2
= P2 x = 125 x Q2

450
= 56,250.00

Example 2. Price elasticity of demand

If Theresa sells tilapia for P80 per kilo, the demand for it is 200. When she raises it by P20, the Qd diminishes to 100. At what price will Theresa maximize her profit? Is the demand elastic or inelastic?
% Change in Qd = change in Qd Average Qd = 100-200 200 + 100 2 = -0.67

% change in P

= change in P/ Average P
= 100 80/ 80 + 100 2 = 0.22

Price Elasticity of Demand = % change in Qd= 0.67 % change in P 0.22 = -3.045 or 3.045, elastic

Computing for total Revenues

COMPARING THE TWO RESULTS, WE CAN OBSERVE THAT AT AN ELASTIC DEMAND FOR TILAPIA, PROFIT IS MAXIMIZED AT THE ORIGINAL PRICE.

TR1 = P1 x Q1 = 80 x 200 = 16,000

TR2 = P2 x Q2 = 100 x 100 = 10,000

INCOME ELASTICITY OF DEMAND

SUMMARY OF INCOME ELASTICITY OF DEMAND: >1 = LUXURY GOOD;

<1 = NECESSITY;

Qd2 Qd1 % CHANGE IN Qd = Qd1 + Qd2/2 % change in Y Y2 Y1 Y1 + y2/2

>0 = NORMAL GOOD;

<0 = INFERIOR

Example 1 Income Elasticity of Demand

Chris earns a monthly salary of P5,000 and she consumes P1,000 worth of chicken per month. When her income increased by P2,500/month, she started to consume P2,000 worth of chicken meat a month. Is Chris demand for chicken meat normal, inferior, necessity or luxury?

INCOME ELASTICITY OF DEMAND

= 0.67 = 1.68

0.40
THE RESULT IS GREATER THAN 1, HENCE THE DEMAND FOR CHICKEN IS NORMAL AND MIGHT BE CONSIDERED AS A LUXURY GOOD.

% CHANGE IN QD = 2000-1000 = 1,000 = 0.67 1000 + 2000/2 1,500 % CHANGE IN Y = 7,500 5,000 = 2,500 = 0.40 5,000 + 7,500/2 6,250

EX. 2 Income elasticity of Demand

= % change in Qd
= 50-100 = -50 = -0.67 100+50/2 75

= % change in Y
= 7,500-5000 = 2500 = 0.40 5000 + 7500/2 6,250

=-0.67/0.40 = - 1.68

Every month Mang Ernesto earns P5,000 as a fishball vendor. During this period, he also consumes 100 tuyo. When his income increased by P2,500, he began lessening his consumption of tuyo to 50. From the given, is tuyo normal, inferior, or common good for Mang Ernesto?

Cross elasticity of demand

goo Qd1 Qd2 P1 d P2

SUMMARY OF CROSS ELASTICITY:

If:

= 0 (X AND Y ARE NOT RELATED 0 (POSTIIVE) - SUBSTITUTES < 0 (NEGATIVE) COMPLEMENTS

CROSS ELASTICITY OF DEMAND

= % CHANGE IN DEMAND FOR PRODUCT X ----------------------------------% CHANGE IN THE PRICE OF PRODUCT Y
(Qd2 Qd1) (Qd2 + Qd1/2) ------------------------------------(P2 P1) (P1 + P2/2)

% change in demand for product X

Qd2-Qd1 = 5-4= 2 1 45 = 0.22

% change in demand for product Y

=32= 1
2+3 25

Qd1 + Qd2/2 4+5

= P2 P1 0.40
P1 + P2

Cross elasticity of Demand = 0.22/0.40 = 0.55, greater than 0, hence product X & Y are

Cross elasticity of Demand

% change in product X % change in product Y

Goo d

Qd1

Qd2

P1

P2

5-2
2+5/2

= 3
3.5

= 0.86

--------------------------------- = -0.86, 1-3 3+1/2 = -2 = - 1 2

PRODUCTS X & Y ARE COMPLEMENTS

PRICE ELASTICITY OF SUPPLY

% CHANGE IN Qs % change in P
Change in Qs/ Average Qs Change in P/Average P

(Qs2 Qs1)/(Qs1+Qs2/2) (P2 P1)/(P1+P2/2)

Summary of Price Elasticity of Supply = 1 Unitary Elastic 1 Elastic < 1 Inelastic

Price Elasticity of Supply

The old price of sardines is P10. At P10, a producer can supply 100 cans of them. When the selling price changes to P12, the producer was able to increase its production to 120 units. Solve for the price elasticity of supply

= % change in Qs % change in P = 20/110 = 0.18 2/11 0.18 = 1, the sardines is unitary elastic

Price elasticity of Supply

Suppose that the old price of instant noodles is P5 and a seller can produce 100 packs of them. When the price rose by P2, the producer has doubled his production. How elastic is his supply for noodles?
% change in Qs/% change in P =change in Qs/Average Qs =100/150 = 0.67 --------------------------------------=change in P/Average P = 2/6 = 0.33

--------------------------------------0.67/0.33 = 2.03 elastic

Price elasticity of Supply

A 14 inch TV is originally sold at P5000. at this price, an appliance store is able to sell 100 TVs in the market. The following month, the new price of TV is P7,500. However, the store has only increased its output by 5 units. How elastic was the supply of the stores TV? % change in Qs/% change in P

Change in Qs = 5 = Average Qs 102.5

0.049 =0.05

Change in P = 2,500 = 0.4 Average P 6,250

0.05/ 0.4

0.125, inelastic

Thank you

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