Manegerial Eco.

1. Elasticity and its Types Elasticity is a measure of responsiveness used in demand analysis Quantitatively. this is defined as the change in a dependent variable resulting from a change in the value of an independent variable. Demand elasticity measures the impact or magnitude of changes in demand-determining variables, such as price of the good, prices of related goods, and income. Price elasticity of demand. This measures the relationship between a change in the quantity demanded of a particular good and a change in its price. Price elasticity of demand is a term in economics often used when discussing price sensitivity. The formula for calculating price elasticity of demand is: priceelasticityof demand= % changein quantitydemanded % changein price Point elasticity This measures elasticity at a given point on a function or on the demand curve, and is given by APIP AP Q Arc price elasticity This measures price elasticity between two points on the demand curve, and is given by Price elasticity and its range of values Note that the price elasticity of demand is always interpreted in terms of its absolute value when we are referring to whether demand is elastic or inelastic. Its negativity arises simply because of the inverse relationship between price and quantity demanded. Table 1 shows the range of values and its interpretation. Table 1. Range of Values PED Demand Interpretation Consumers responsive to price changes Consumers not very coponthe to price changes Unit chartic Intermediate cane Perfectly elastic Infinitely responsive (buy nothing if price rises) Perfectly inelastic Totally unresponsive (buy the same if price rises)Source: Wilkinson, Nick (2005). Managerial economics A problem-solving approach Relationship of price elasticity with revenue, cost, and profit The concept of price elasticity is important for managers in order to determine the right price to charge and make forecast. The table below (2) summarizes the relationship of price elasticity with the firm's revenue, costs, and profit. Demand Price Quantity Revenue Costs Profit Elastic more Tmore Inelastic Iless Tless Unit elastic same same same same I = increases; fmore = increases by a larger proportion; thes = increases by a smaller proportion; |same= increases by the same proportion: | = decreases; [ more = decreases by a larger proportion; Iless =decreases by a smaller proportion; [same = decreases by the same proportion; ?= unknown without further information Table 2. Relationship of price elasticity with revenue, cost, and profit Soured. Wilkinson, Nick (2001). Managerial deomonies A problom-making approach Some important implications: Firms will always maximize revenue if it charges a higher price when demand is inelastic. Firms will maximize sales if it cuts its price on a product with elastic demand. actors affecting the price elasticity of demand Availability of substitutes. Perhaps this is the most obvious factor affecting demand elasticity is the availability of substitutes. The more there are close substitutes available in the market the more elastic is its demand. Proportion of income spent on the commodity. When an item represents a relatively small portion of the total budget, we tend to pay little attention to its price (thus, inelastic), other factors remaining the same. Time period. Demand tends to be more elastic in the longer term as consumers have enough time to look for and switch to different products.Income elasticity of demand. This is defined as the measure of responsiveness or sensitivity in the demand for a product when consumers' income change, and is given by incomeelasticityof demand- o changein quantitydemanded % changein income Income elasticity and its range of values Income elasticity can be positive or negative, depending on whether the product is normal or inferior. Normal products can be further divided into luxury products and staple products, according to whether the income elasticity is more than one or less than one respectively. This is summarized in Table 3 YED Demand Interpretation 31 Income elastic Luxury products O