ECO101 Lec 8

ELASTICITY (PART 1)
HOW TO APPROACH THE STUDY OF

MICROECONOMICS
 Microeconomics is the branch of economics that deals with
human behaviour and choices as they relate to relatively
small units: an individual, a firm, an industry, a single
market.
 It involves players (consumers, business firms, and factor

owners) who have an objective, faces some constraints and
has to make choices.
 Let’s look at each of these players and what their objective,

constraints and choices are.
 All the choices are made in market settings, with different
markets having different setups.
Players Objective Constraints Choice
Consumers Maximize utility Finite Incomes Chose between different
of satisfaction by Positive Prices bundles using marginal
consuming goods analysis
and services
Firms as Maximize profit Positive Prices of Chose mix of factors

Buyers Resources/Factors and that will minimize cost
cover opportunity costs using marginal analysis
Firms as Maximize profit -Consumers who wants to Chose quantity to

Sellers pay less for more produce, sell and decide
-Competitors who will on price
undercut prices
Factor Maximize income -Finite amount of factor Chose to sell units of

Owners earned by selling -Market decides the price factor based on marginal
factors they will get analysis
ELASTICITY (PART 1)

Price Elasticity of Demand: A measure of the
responsiveness of quantity demanded to changes in
price.
 Measured by dividing the percentage change in the
quantity demanded of a good by the percentage change
in its price.
 Coefficient of Price Elasticity of Demand. How do we

interpret this?
PRICE ELASTICITY OF DEMAND

Using percentage changes can at times lead to
conflicting results depending on whether price falls or
rises.
 Economists compute price elasticity of demand using
midpoints as the base values of changes in prices and
quantities demanded
 Numerically?
ELASTICITY IS NOT SLOPE
Point Price Quantity Demanded
A 12 50
B 10 100
C 8 150
• What is the Price Elasticity of Demand from Point A to B?

• What is the slope from A to B?
• What is the Price Elasticity of Demand from Point B to C?
• What is the slope from B to C?
• Are they the same?

ELASTIC DEMAND
 The demand when the
percentage change in
quantity demanded is
greater than the percentage
change in price. Quantity
demanded changes
proportionately more than
the price.
 %∆Qd > %∆P  Ed > 1 
Demand is elastic
INELASTIC DEMAND
quantity demanded is less
than the percentage
change in price. Quantity
demanded changes
proportionately less than
the price.
 %∆Qd < %∆P  Ed < 1
 Demand is inelastic
UNIT ELASTIC DEMAND
quantity demanded is equal
to the percentage change in
price. Quantity demanded
changes proportionately to
the price.
 %∆Qd = %∆P  Ed = 1 
Demand is unit elastic
PERFECTLY ELASTIC DEMAND CURVE
 The demand when a small
percentage change in price
causes an extremely large
quantity demanded (from
buying all to buying
nothing.)
 Ed = ∞ (Infinitely large)
PERFECTLY INELASTIC DEMAND CURVE
quantity demanded does not
change as price changes. So
the demand is completely
UNRESPONSIVE to
changes in demand.
 Ed = 0
SUMMARIZING…
PRICE ELASTICITY AND TOTAL
REVENUE (TOTAL EXPENDITURE)
 Total Revenue of a seller equals the price of a good tines
the quantity of the good sold.
TR = P * Q
 Question: Does rise in price mean higher revenue?

 When prices increases  Quantity demanded will fall
because Demand is downward sloping.
 How does changes in prices impact total revenue?
 Whether TR increases or decreases or remains same,

depends on whether percentage change in quantity
demand is less than, greater than or equal to percentage
change in price  Price Elasticity of Demand.
ELASTIC DEMAND AND TOTAL
REVENUE
 Quantity demanded changes
proportionately more than the
price.
 %∆Qd > %∆P  Ed > 1 
Demand is elastic
 If price falls, Qd rises by a
bigger percentage  Sales of
the good rises by a bigger
percentage  TR revenue
rises.
 If price rises, Qd falls by a
bigger percentage  Sales of
the good falls by a bigger
percentage  TR revenue falls.
INELASTIC DEMAND AND TOTAL
REVENUE
proportionately less than the
price.
 %∆Qd < %∆P  Ed < 1 
Demand is inelastic
smaller percentage  Sales of
the good rises by a smaller
percentage  TR revenue falls.
 If price rises, Qd falls by a
smaller percentage  Sales of
the good falls by a smaller
percentage  TR revenue
rises.
UNIT ELASTIC DEMAND AND TOTAL REVENUE

proportionately equal to the
price.
 %∆Qd = %∆P  Ed = 1 
Demand is unit elastic
same percentage  Sales of the
good rises by a same percentage
 TR revenue stays same.
 If price rises, Qd falls by the
same percentage  Sales of the
good falls by same percentage
 TR revenue stays same.
SUMMARIZING…

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ELASTICITY (PART 1)

HOW TO APPROACH THE STUDY OF

 It involves players (consumers, business firms, and factor

 Let’s look at each of these players and what their objective,

Firms as Maximize profit Positive Prices of Chose mix of factors

Firms as Maximize profit -Consumers who wants to Chose quantity to

Factor Maximize income -Finite amount of factor Chose to sell units of

 Coefficient of Price Elasticity of Demand. How do we

• What is the Price Elasticity of Demand from Point A to B?

• Are they the same?

 Question: Does rise in price mean higher revenue?

 Whether TR increases or decreases or remains same,

 Quantity demanded changes

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