ECO 501.1; ECO 501.

2
MANAGERIAL ECONOMICS

Summer Semester, 2021

BRAC University
Week 5: Elasticity of Demand
 WEEK 5: Elasticity of Demand
Alternative to Price System
• For Elasticity: • Blank Slide
McGuigan, et al.
CHAP 3: Demand Analysis: 72-98

• For Alternative to Price System:

Stiglitz
CHAP 2: 32-33
 WEEK 5: Elasticity of Demand
Alternative to Price System
• Rationing by Queues: • Rationing by Lotteries:
• 1. How will people queue? 1. What is a lottery?
2. For what type of a good would 2. What type of goods can be
people queue? allocated as a lottery?
3. If queueing is not followed 3. If the good is not allocated
what inefficiency may arise? through a lottery, what
4. THINK about an example you inefficiency may arise?
can exploit 4. THINK about an example you
can exploit
 WEEK 5: Elasticity of Demand
Alternative to Price System
• Rationing by Coupons: • IF THE ABOVE THREE
• 1. What is a coupon? ALTERNATIVES TO PRICES
2. What type of a good can be APPEAR AS AN ASSIGMENT, You
offered via coupons? This good shall be expected to address the
be in your organization or four points raised here.
elsewhere • The Four Questions will have to
3. If the good is not offered by be addressed in your case study.
coupons what inefficiency may And how these Four Questions
that lead to? relate to your case study the
4. THINK about an example you way the Assignment problem is
can exploit framed.
 Elasticity of Demand: Intro
• Why elasticity of demand? • One Example:
• As price changes by a unit, If the price of insulin increases
quantity demanded moves in by 5%, how will its demand
the opposite direction. This is a respond for a diabetic patient?
general law. Possibilities:
I. Decrease by more than 5%
• However, the demand of II. Decrease by 5%
different goods respond III. Decrease by less than 5%
differently to the same price IV. Does not decrease
change. This has implication on For goods that have no close
many business decisions. substitutes, Option IV
 Elasticity of Demand: Intro
• Option IV: Does not decrease • Inelastic Demand:
• If price increases by 5%, and • Demand less responsive to
demand remains unchanged, change in price.
what effect does that have on • Demand less responsive to
revenue for the firm? change in non-price factor.
• The revenue of the firm will • When consumer’s response to
increase. Demand does not change is restricted, the demand
change. People buy the same changes little before and after a
quantity before and after price change (price and non-price)
change.
 Elasticity of Demand: Intro
• Another Example: • Why consumer response to price
If the price of a hi-end mobile change is important for managers?
decreases by 5%, how will its • If after a price decrease, consumers
demand respond for households? tend to buy more than the
Possibilities: percentage of the price decrease,
I. Increase by more than 5% revenue of firms increase. THINK
II. Increase by 5%
III. Increase by less than 5% • Under what situations may this
IV. Does not increase happen? THINK
For goods that have close • In this week, this is what we shall
substitutes, where consumers can try to cover
switch easily, Option I
 Price Elasticity of Demand
• Price elasticity of demand: 73 • How to read a ratio:
• Elasticity is defined as a ratio of ED=%∆QD/%∆P generates the
percentage change in quantity following possibilities:
demanded TO percentage ED>1; ED<1; ED=1; ED=0; ED=ꝏ
change in the factor that causes • These possibilities. Effect on
change in quantity demanded revenue before & after price
• Price Elasticity of Demand: change.
ED = %∆QD/%∆P • Revenue: R=PXQ
ED: Elasticity of demand; %∆QD: Example: IF P↑, but Q↓ more
%Change, Quantity demand; than P↑, R↓ than before.
%∆P: %Change, Price
 Price Elasticity of Demand
• When ED>1: Price-Elastic • When ED<1: Price-Inelastic
If ED=%∆QD/%∆P, Then %∆QD>%∆P If ED=%∆QD/%∆P, Then %∆QD<%∆P
Demand responds to price change. Demand does not respond to price
1. If P↑ 1%, QD↓ more than 1%. change.
Effect on Revenue: R=PXQ. 1. If P↑ 1%, QD↓ less than 1%.
P↑ by 1%, Q↓ more than 1% Effect on Revenue: R=PXQ.
R↓ than before price change. P↑ by 1%, Q↓ less than 1%
Because: ∆P(↑)<∆Q(↓) R↑ than before price change
Because: ∆P(↑)>∆Q(↓)
2. If P↓ 1%, QD↑ more than 1%.
Effect on Revenue: R=PXQ. 2. If P↓ 1%, QD↑ less than 1%.
P↓ by 1%, Q↑ more than 1% Effect on Revenue: R=PXQ.
R↑ than before price change. P↓ by 1%, Q↑ less than 1%
Because: ∆P(↓)<∆Q(↓) R↓ than before price change
Because: ∆P(↓)>∆Q(↑)
 Price Elasticity of Demand
• When ED=1: Price Unit Elastic • When ED=0: Perfectly Price Inelastic
If ED=%∆QD/%∆P, Then %∆QD=%∆P If ED=%∆QD/%∆P, Then %∆QD=0
Demand neutral to price change. Demand does not respond to price
1. If P↑ 1%, QD↓ also by 1%. change ‘at all’.
Effect on Revenue: R=PXQ. 1. If P↑ 1%, QD does not ↓
P↑ by 1%, Q↓ also by 1% Effect on Revenue: R=PXQ.
R unchanged P↑ by 1%, Q↓ by 0%
Because: ∆P(↑)=∆Q(↓) R↑ than before price change
2. If P↓ 1%, QD↑ also by 1%. Because: ∆P(↑)>∆Q(=0)
Effect on Revenue: R=PXQ. 2. If P↓ 1%, QD does not↑
P↓ by 1%, Q↑ also by 1% Effect on Revenue: R=PXQ.
R unchanged P↓ by 1%, Q↑ more than 1%
Because: ∆P(↓)=∆Q(↓) R↓ than before price change
Because: ∆P(↓)>∆Q(↑)
 Price Elasticity of Demand
• When ED=1: Price Unit Elastic • When ED=0: Perfectly Price Inelastic
If ED=%∆QD/%∆P, Then %∆QD=%∆P If ED=%∆QD/%∆P, Then %∆QD=0
1. Response in DD = Change in Price 1. Response in DD = 0, no response
2. P↑; P↓ both lead to same change in 2. Demand does not respond to price
demand after price change. 3. P↑: Rise in revenue
4. P↓: Drop in revenue
• When ED>1: Price-Elastic • When ED<1: Price-Inelastic
If ED=%∆QD/%∆P, Then %∆QD>%∆P If ED=%∆QD/%∆P, Then %∆QD<%∆P
1. Response in DD > Change in Price 1. Response in DD < Change in Price
2. Demand is responsive to price 2. Demand less responsive to price
3. P↑: Drop in revenue 3. P↑: Drop in revenue
4. P↓: Rise in revenue 4. P↓: Rise in revenue
Elasticity in Graphs
• LEFT PANEL: Inelastic Demand
• ED=%∆QD/%∆P. ED<1
%∆QD<%∆P
• Interpret this.
• What happens to revenue, when
1. Price falls? Revenue falls
2. Price rises? Revenue rises
Elasticity in Graphs
• RIGHT PANEL: Elastic Demand
• ED=%∆QD/%∆P. ED>1
%∆QD>%∆P
• Interpret this.
• What happens to revenue, when
1. Price falls? Revenue
2. Price rises? Fall
Elasticity in Graphs
• Perfectly Inelastic Demand
• ED=%∆QD/%∆P. ED=0
%∆QD=0 for all %∆P
• Interpret this.
• What happens to revenue, when
1. Price falls? Revenue falls
2. Price rises? Revenue increases
 Other Factors Affecting Elasticity
• Price studied as first factor to • 2. If YES, with how much or how
which demand responds. Thus: less flexibility: elastic vs inelastic
ED = %∆QD/%∆P 3. What factor other than price
• ∆QD can respond to a different is responsible for this response?
denominator. Elasticity of 4. What is the nature of the
demand can be applied to response of this variable?
different real world situations.
• The points to note are:
1. Can ∆QD respond to the
change in the variable?
 Other Factors Affecting Elasticity
• Availability and closeness of • Percentage of consumer’s
substitutes budget
• How does your demand respond • Does the good consist a large
when substitutes are available percentage of your budget? If
and when they are not? yes/no, how does your demand
• How does demand respond? respond?
Not easily available?
How close is the substitute?
 Other Factors Affecting Elasticity
• Positioning the good • Time period of adjustment
• How is the good perceived in the • Does the consumer have time to
eyes of the consumer? Think switch to an alternative, or not?
• How does a consumer perceive a • No time to respond: Inelastic
good? Time to respond: elastic
 Other Factors Affecting Elasticity
• Is the good a necessity or a • How many functions of use
luxury? does a good have?
• How does consumer demand • How does consumer demand
respond to price increase respond to price increase
(decrease) when a good is: (decrease) when a good has:
a necessity: inelastic; price↑ Multiple uses:
a luxury: elastic; price↓ few uses:
 Assignment No 1
• Assignment No 1 will be given • FORMAT
after the TUE Class in Week 5. • 1. A cover page with details
• Submission: 2. Two Sides to Write on
Google Classroom; or 3. Bibliography mentioned
ext.asrarul.islam.bracu.ac.bd 4. Concepts till now are included
• Please get G Suite 5. Plagiarism check will be made
6. Late submission may be
• Distribution: TUE July 13, 2021 Penalized- since sufficient time
Deadline: Noon TUE July 20, 20 will be given to write.