Copyright © Wee Qian Hui

LECTURE 2
ELASTICITY & CONSUMER BEHAVIOUR

PRICE ELASTICITY OF DEMAND

•
% 0 in
Qty Demand from 1%0 in Price .

Measure of responsiveness of Qty Demanded to 0in price .

E. G.
p

Price of beef ☆ 1%

Qty of beet demanded ↑ 2%

Price Elasticity Of Demand is -2 .

CALCULATION
•

symbol for elasticity - E

% 0 Qty Demanded "%-

-

in 100%

¥
✗

¥g
e = E =
✗
% 0 in Price OI

1 x2 - x1 Delta Q
•
Always negative - AP , KD 01 top , PD = =
slope y2 - y1 Delta P
Ignore sign & consider absolute value

ELASTIC DEMAND -

E. 9 .
Grocery products

• > 1 in absolute value ,

Demand is elastic

• % 0 in QD > % ☐ in P

•
Demand is responsive to price

INELASTIC DEMAND -
E. a. Medical services .

• < 1 in absolute value demand in inelastic

,

• % ☐ in QD < % Din p

• Q-14 Demanded is not very responsive to price .

UNIT ELASTIC DEMAND -

Rarely happens

• = 1 in absolute value demand is unit elastic .

• % 0 in QD =
Yoo in P
 DETERMINANTS
1
Substitution Options

Move options more elastic .

2
Budget shave -

Low shave =
Low priced items

large share ,
move elastic .

3 Time

long time to adjust ,

move elastic .

PRICE ELASTICITY & SLOPE

D1 :
steep slope , stope is smaller

Less Elastic
More Elastic weak response ,
More inelastic ,
unresponsive
•

D2 :
Flat slope , stope is bigger

strong response ,
Elastic ,
responsive

E ON A STRAIGHT -

LINE DEMAND CURVE

price elasticity different at each point

•

•
Slope is the same for the demand curve

•
¥ decreases as price to &
quantity $ .

Pattern

price to
•
E
changes systematically as

•
At PP & to Q , large > Elastic

•
At midpoint > unit elastic

•
At top & A Q , small > Inelastic

TWO SPECIAL CASES

1
Perfectly Elastic Demand 2
Perfectly Inelastic Demand

Infinite E Of demand Zero E Of demand

P P D

Q Q

( L at all
consumers super price sensitive Not price sensitive

OP will remove entire Demand curve

Demand curve doesn't change despite ☐ price
Any
only 1 price accepted
 E & TOTAL EXPENDITURE

When PP expenditure to
•
total can 4 or remain the same .

, , ,

0 in expenditure depends on E .

•
Total Expenditure = Total Revenue

calculate as P ✗ Q .

✓ Total Expenditure :
Area of black rectangle

IF BELOW MIDPOINT OF CURVE

EXAMPLE :
• Movie tickets increases $2 → $4 .

• Both A & B below midpoint of curve

•
inelastic portion of demand curve

• Total revenue * when price $ .

IF ABOVE MID POINT OF CURVE

EXAMPLE :

•
Movie tickets increases $8 → $10 .

• Both A & B above midpoint of curve

•
Elastic portion of demand curve

•
Total revenue to when price $ .

MIDPOINT FORMULA FOR E -

More accurate .
use when calculating E over a range of price .

OQ / [ ( Qa + QB) /2 ]
E =

OP / [ ( Pat PB ) / 2 ]

CROSS -

PRICE ELASTICITY OF DEMAND -

can also use midpoint formula

%DQ Of 1% DP Of B
good A good
•
from a .

* DO NOT IGNORE SIGN

•
sign of cross -

price E shows v15 between goods % DQ Of good A

g =

•
complements have negative cross -

price E. % OP of good B

•
substitutes have positive cross -

price e.

INCOME ELASTICITY OF DEMAND

•
% DQ from 1%0 in income .

* DO NOT IGNORE SIGN

•
Income E Can be t) or t) % DQ
e =

•
Positive income E is a normal good .
%8 income

•
Negative income E is an interior good .
PRICE ELASTICITY OF SUPPLY

•
% in
Qty supplied from 1% in Price .

Measure of responsiveness of Qty supplied to in price .

CALCULATION
Qty supplied
Q /Q
E =
E = P 1
OR ✗
PIP Q slope
✓
Always a positive value

Always positive
•

ELASTIC DEMAND UNIT ELASTIC DEMAND

• •
• E as Q • 8=1 for both Point A & B
,

• Point A 's E > Point B 'S E • % 0 QS = % 0 in P

•
% ☐ in QS > % 8 in P

PERFECTLY INELASTIC

•
Zero price elasticity of supply ( inelastic )

•
No response to change in price

Quantity supplied stays constant despite price change .

PERFECTLY INELASTIC

•
infinite price elasticity of supply ( elastic )
•
sell all you can at a fixed price -

At current price producer can supply any quantity .

But when the price
,

shifts at any amount the entire

supply curve just vanishes .

,
 DETERMINANTS

input Flexibility
uses adaptable inputs ,
more elastic .

Easy to
get hold of inputs ,
elastic -

can buy item A instead of item B .

2
Mobility Of Inputs
Resources move where needed ,
more elastic .

workers can easily move from one city to the other ,

more elastic .

Easy to get hold of resources needed .

production expensive B.
F- -

g .
If at City A is more , move to
city

3 Produce substitute inputs

Alternative inputs easy to find ,
more elastic .

Using machines to replace workers .

If easy to find ,
then supply becomes more elastic .

4 Time

Long run more elastic .

If price increase by 50% ,

producers cannot respond fast as they are not prepared . A year

from now will increase the elasticity due to longer time horizon .

UTILITY

Needs versus wants

Needs :
Goods required for subsistence .

Wants :
Beyond subsistence ,
behavior is driven by wants .

E- g. Rice or Noodle , Hamburger or sandwich

want depend on price

unlimited wants with limited resources ( budget ) means consumers have to

prioritise wants when making choices .

Calculation

Marginal Utility :
The additional utility from consuming one more .

Marginal utility =
in utility
in consumption

Marginal utility will always eventually decrease ( lesser satisfaction ) due to human nature .
 Law Of Diminishing Marginal Utility
Definition !

to decrease
•
Tendency for additional Utility gained from consuming an additional unit of a good ,

as consumption increases beyond some point .

to *
Buy B- Of a single good , marginal utility to

•
Marginal utility can increase at levels of consumption
• First unit stimulates your desire for more

First Unit Of food / drinks

-

Eventually marginal utility declines

•
continue consuming

•
Apply lost -

Benefit Principle

consume an additional unit as long as long as the marginal utility I benefit ) is greater than

the marginal lost .

Budget Allocation

•
Maximise utility when the marginal utility per dollar spent is the same for all
goods .

NO Money Left The Table Principle

••
On

•
•
current spending has marginal utility of a dollar spent on one good higher than the marginal
utility of a dollar spent on the other good .

•
Take a dollar away from the good with low marginal utility and spend it on the good with high

marginal utility .

•
Marginal utilities per dollar begin to equalise
.

•
E.g .
Sarah 's ice cream

Budget =
$400 ,
Chocolate =
$2 / pint ,
vanilla = $1 / pint

1
Buy 200 pints of vanilla & 100 pints of chocolate .

MU : $12 for vanilla ,

$16 for chocolate .

MU
per $ for vanilla 1211 12
= =

MU per $ for chocolate =

16/2 = 8

2
Increase vanilla by 100 and reduce chocolate by 50 .

MU :
$8 for vanilla ,
$24 for chocolate

MU per $ for vanilla 811 8

= =

MU per $ for chocolate =

24/2 = 12
 3
Optimal combination highest utility
:
. 250 Vanilla ,
75 Chocolate .

MU / Price same for all goods .

MU :
$10 for Vanilla ,
$20 for chocolate

MU
per $ vanilla =
$1011 =
$10

MU per $ Chocolate =
$2012 = $10

•
Rational Spending Rule

Definition !
•
spending should be allocated across goods so that the marginal utility per dollar is the same for

each good .

•
MUA PA =
MU B P
B

MU per dollar spent on A = MU per dollar spent on B .

•
Substitution Effect

When the price of a good goes up ,

substitutes for that good are relatively more attractive .

At the higher price is demanded because some switch to the substitute good
-

•
Income Effect

Changes in price affect purchasing power A buy to

'

the buyers .

price ,
.

MARKET & SOCIAL WELFARE

• Market is the
aggregation of individual consumer demand and producer supply .

•
consumers and producers are able to acquire welfare from consumption &
production of
products in

the market .

Individual & Market Curves

Market

The market demand is the horizontal sum of individual demand curves .

At each possible price ,

add up the number of units demanded by individuals to get the market demand .

supply
ECONOMIC surplus

welfare of the society ( Economic surplus ) : obtained by the sum of the consumers & producers
welfare .

Economic surplus =
consumer surplus + producer surplus

consumer surplus

consumer surplus : difference between the buyer 's reservation price & the market price .

•
consumer surplus on a graph

•
When a product is sold in whole units ,
the demand curve is a stair -

step
consumer function .

surplus

I 0
•
Total consumer surplus =
area under demand curve & above market price .

$5 Of consumer surplus $41S I

1St sale generates .
( 2nd unit ,
& SO on . .

Reservation price of $11 minus $6 market price .

If the market supplied only one unit the maximum price ( willing to be paid ) would be $11
-

.
,

•
For second unit ,
the price is $10 ,
and so on .

Last buyer gets no consumer surplus

•
.

Every consumer only required to pay $6 per unit ( market price )

-

If they are willing to pay above $6 , they earn additional welfare .

< $6 ,
no welfare .

↳
Did not get the product
B- price =
$2 , Qty =
4,000 liters per day .

consumer surplus =
I ✗ b ✗ h

Area in this e. g Ex $2,000

=
4,000 ✗ $1 = .

marginal cost which is the supply curve

Producer surplus
.

/
Producer surplus
:
difference between the market price and the seller 's reservation price .

•
Producer surplus on a
graph

produce surplus =
area above supply curve & below market
price

E. g. willing to sell at $2 ( reservation price , marginal cost )

you can sell at $10 .

It sold at $10 ,
welfare = $8 .