hello and welcome back to the second week of the foundation course in managerial economics
last week we developed the concept of demand and supply and we developed the concept of
how demand supply equilibrium shows us what the price the the market price is and what
the market quantity is which basically clears the market and today we are going to extend
the discussion and talk about something called elasticity of demand and elasticity of supply
. so uh elasticity is so let me let me just
quickly go through what we plan to learn this week we are going to talk about what is elasticity
uh most of know what elasticity is especially people with uh science and engineering background
are very much uh conversant with the concept of elasticity how it is measured etc
and then we are going to see how is the concept of elasticity applied in economics in this
uh framework of demand and supply and then we are going to talk about what do we mean
by price elasticity of demand and what is price elasticity of supply and why is it why
are we measuring these elasticity in the first place what do we hope to achieve or understand
when we are uh calculating the elasticities of demand and supply what what understanding
or what further understanding of the market do we achieve by studying the elasticity of
demand and elasticity of supply and we are going to see that uh elasticity actually uh
tells us a lot about the revenue or the expenditure uh that the revenue that the producer is hoping
to get out of producing the total number of goods or selling the total of number of goods
in the market that is the revenue and we are going to see that there is a linkage between
the revenue that he may expect with the elasticity of say the supply curve and similarly with
the elasticity of the demand curve when the elasticity of the demand curve actually is
going to tell us that how much extra units of output the consumer is likely to buy uh
when the price of that product falls so uh just holding on to that thought lets
proceed and uh what other elasticities can one measure so we are going to start with
the concept of price elasticity of demand and later we are going to talk about price
elasticity of supply but uh we are going to also talk about diverse uh types of elasticities
we are going to talk about cross price elasticity income elasticity and once we are conversant
with the idea of elasticity we are going to see that its very easy to understand uh how
demand or supply would respond to changes in any of uh say price or income or uh say
any other determinant of demand or supply that we talked about in the last week .
so uh what is elasticity so the the standard definition of elasticity is the ability of
a body to resist a distorting influence or stress that is uh we say that if it is in
in physics it is if the body can after distortion or stress if the body can come back to its
original uh shape and size so that is elasticity so we are using this concept here and we are
saying that elasticity of demand implies how much demand responds to changes in variables
like price or income so uh how much demand is resisting a increase
in price or how much distortion is happening to say demand or supply when something like
any of the determinants of demand or supply say for example price when the price changes
how much demand is changing and how much supply is changing in response to that price we are
trying to evaluate that so so the definition here we are using is elasticity is a numerical
measure of the responsiveness of quantity demanded or quantity supplied to one of its
determinants this is the most general definition of elasticity
that we are going to use and a very specific definition of price elasticity of demand that
is how much demand responds to change in price is simply given by the or it is simply measured
by the ratio of percentage change in quantity demanded to percentage change in price that
is how much demand responds to price change so uh so we can start with an example lets
lets uh start with an example and we are going to take exactly the same example of the ice
cream market that we introduced in the previous class .
so uh say this is my demand schedule in the market uh these are the prices and these are
the quantity demanded of ice cream so the prices were 10 20 30 40 50 60 and 70 and against
these prices the quantity demanded in the market were 22 20 17 15 13 10 and 8 so uh
we are assuming that this is the quantity so if the price is say 10 rupees per cone
of ice cream the total amount that the market is going to demand is say 22000 kgs of ice
cream or whatever depending on the size of the market
so unit is not so important here its just enough to see that the quantity is increasing
is increasing as prices price is decreasing so uh this is the uh demand schedule of the
ice cream now where does elasticity come in say for example i am a ice cream uh producer
and i decide that somehow it does not it is not making sense for me to so earlier in the
last class what was the equilibrium that we arrived at we arrived at this equilibrium
so say currently the market price is 40 and i am selling 15000 cones of ice cream so now
uh and what is my revenue the revenue that i am earning that this is the total amount
of ice cream this is the total sale that i am that is happening in the market that is
600 so now say for example uh the ice cream producers decide that uh 40 rupees is not
enough like my costs are going up say for example my refrigeration cost as electricity
bills are have gone up and refrigeration cost has gone up so i uh would like to increase
my price from 40 to say 50 rupees so my concern is by the law of demand i know that if i increase
my price the quantity demanded in the market is going to go down so to the producer the
concern is is my demand is my total revenue going to continue to be this or is it going
to be more or is it going to be less it can be more if the amount the quantity
or the response in the market to the price change is not so much as the price change
say for example if my p goes up by a higher percentage than q in that case i can hope
to have a increase in revenue so in that case it makes probably makes sense for me to increase
the price so lets see what happens here so uh so now i am going to see uh so so so
here uh if if if i would like to increase my price from 40 to 50 i am going to see what
my elasticity of demand is and as per the definition that we have shown in the slide
earlier slide its percentage change in quantity demanded to percentage change in price so
if i increase my price to 50 rupees then by definition my elasticity of demand against
price is 25 percent increase in price and
and around and around 13 percent increase sorry uh it is going to be a increase in price
so 13 percent fall in quantity sold so if my price is the amount by which the
price is increasing is more than the amount by which the percentage by which quantity
is increasing uh it makes sense for me to uh increase the price so here if i increase
this it to uh 50 i can see that here it is 650 okay now if i decide to increase it to
60 then what happens then i am seeing that it is increasing to 60 and my price has sorry
my the price has increased to 60 and my quantity has fallen to 10 my but my total revenue continues
to be 600 so in that case there is the same amount of
increase in price the same amount of increase in price is leading to same amount of decline
in quantity and finally if i decide that i my costs are really really high and i would
really like to increase the price let me increase it to 70 in that case what i see is it is
560 so when it is 560 i clearly see that there is a drop in my revenue so having said that
the this is just to develop the concept of elasticity that basically elasticity what
it is telling me . elasticity is telling me that since p and
q move in opposite directions since we have a negatively sloping demand curve where this
is p this is q since we have a negatively sloping demand curve every unit of price change
that happens every unit of price change that happens is comes along with a change in quantity
and that is going to change my revenue but right now we have not discussed anything
about uh uh production production function cost etc how how basically the producer decides
if the price is to be increased or not so this is not to say that the the producer is
not going to increase the price this is not to say that since price is he when he increases
the price from 40 to 70 his revenue falls from 600 to 560 so the producer is not going
to increase the price no i am not saying that this concept this this is a very simple example
which i have developed to demonstrate what basically price elasticity of demand means
and what it is what is its implication or usage so along a demand curve so along a demand
curve as i have already said price and quantity move in opposite directions so what do i mean
by that so basically when i say that elasticity of demand is percentage change in quantity
divided by percentage change in price so when price is increasing or decreasing
quantity moves in the opposite direction which implies that elasticity of demand price elasticity
of demand is always less than 0 price elasticity of demand is always less than 0 because the
demand curve has a negative slope because price and quantity moving opposite directions
so elasticity of demand is always going to be less than 0 and let me clean up the board
. so uh so elasticity of demand is always less
than 0 and henceforth whenever i say that elasticity is high or low what i mean by that
is if demand is high or low basically i am taking the price elasticity value in absolute
terms and i am saying whether elasticity of demand is high or low so whenever we say price
elasticity of demand is high or price elasticity of demand is low what we mean by that is the
absolute value of the elasticity this elasticity is always less than 0 but what i what i mean
by elasticity being high or low is the (elasti) the absolute value of the elasticity of demand
is high or low .
okay another point is that uh going back to the same example i
going back to the same example uh sorry i i have to write it once more uh okay so we
took the example that we are starting from this point so equilibrium price is 40 and
the quantity demanded right now in the market is 15 and we are contemplating increasing
the price from 40 to 50 and uh and we know that demand is going to decrease
now what is the response to price increase at this point when i am the the way that elasticity
is calculated how is it calculated it is basically calculated when i am i am doing when i am
trying to calculate this percentage change in quantity so what i uh do is its uh 40 minus
50 divided by 40 into 100 (div) uh i am sorry it is going to be in the this is the price
increase so it will come in the denominator
so this is how i calculate what the price elasticity of demand is when i am trying to
increase the price from 40 to 50 or in other words i am trying to find out how responsive
quantity is to price changes when my price is increasing from 40 to 50 now what happens
when i am trying to calculate exactly the opposite if i am trying to calculate how is
my demand going to change if my change my or if i decide to reduce my price from 50
to 40 is it going to be the same as increasing my
price from 40 to 50 no it is not so in that case if i am (incre) if i am reducing the
price from 50 to 40 in that case my elasticity price elasticity of demand is going to be
so let me just clean this in the same way let me just clean this up and write here that
. when i am increasing from 40 to 50 price is increasing in 25 percent increase in price
and 13 13 percent fall in quantity but when price falls from 50 to 40 this is
a 20 percent fall in price and 15 percent rise in quantity and my elasticity of demand
here is going to be 13 by 25 and here it is going to be 15 by 20 15 by 20 so obviously
they are not the same so they are not the same so basically what that means is at what
point i start calculating my or what point i start calculating my price elasticity of
demand that is important in determining what the price elasticity of demand is going to
be so that kind of makes things a little uneasy or complicated so what we usually do here
is we use the midpoint method . what we do is we use the midpoint method where we use
the midpoint method where basically so so if so this problem basically what we
mean is if i move from a to b i get a certain elasticity price elasticity of demand which
is not going to be equal to if i move from b to a so to resolve that problem what usually
is done is we take the midpoint of the 2 changes both in the numerator and denominator
what we do is midpoint method is uh now i define elasticity of demand as q endpoint
minus starting point values divided by the average of the 2 points of end and starting
point into 100 divided by price endpoint minus starting point divided by the average price
at the 2 points so this basically gives me the midpoint method of calculating the price
elasticity of demand so this is the midpoint method of calculating the price elasticity
of demand and in the following lecture we are going
to talk about so this is in this lecture or in this module we have developed the concept
of elasticity of demand we have seen how elasticity of demand is calculated and we have seen that
basically the value of the price elasticity of demand varies or depends on the point at
which it is calculated and so to resolve the problem what we have done is we have used
something called the midpoint method where we are going to take the average of the beginning
and the endpoint that we are looking at so if the price is increasing or decreasing
we are going to get the same value of elasticity of demand in both the cases unlike in the
earlier case where if your if one is moving from the point a to b on the demand curve
the price elasticity of demand that we get is different from if we move from b to a
so this was about calculation of elasticity of demand and this is general definition of
elasticity of demand and this is price elasticity of demand if it is uh income elasticity of
demand we are going to have income in the denominator if it is something else we are
going to have the so basically whatever uh whatever determinant of demand or supply that
is uh influencing the demand or supply lets lets not talk about supply right away
we will be taking it up in a different different module so uh so to continue uh if we would
like to see what elasticity of demand is with respect to any determinant of demand this
is how we calculate we take the quantity change in response to any determinant of demand divided
by the the change in the determinant of demand so we have taken the example and we are going
to work more on this so we have taken the example of price here because price elasticity
of demand is very important and we are going to talk more about it
so in the denominator here we have price but we can also imagine something like income
say a person uh how much his consumption of say say luxury cars in a economy if there
is increase in income how much consumption of luxury cars increases in the economy so
something like that can be calculated by having instead of p here in the denominator we can
have income variable in the denominator so this is how elasticity of demand uh concept
is used in economics and we are going to use more of it in the later modules and uh and
we will be developing we will be looking at relationship between the demand curves the
shapes of the demand curves and how elasticity of demand depends on them we are going to
look at determinants of elasticity of demand etc in the following module thank you