cross elasticity 1

8/9/2019 Cross Elasticity 1

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CROSS ELASTICITYCROSS ELASTICITY


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DEFINITIONDEFINITION

The responsiveness of demandThe responsiveness of demand

of one good to changes in theof one good to changes in theprice of a related goodprice of a related good eithereither

a substitute or a complementa substitute or a complement


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Percentage change in quantity demandedPercentage change in quantity demanded

of one good caused by the a percentageof one good caused by the a percentage

change in the price of some other good iechange in the price of some other good ie

% change in the Quantity of B% change in the Quantity of B

Ec=Ec= ----------------------------------------------------------------------------------

% change in the price of A% change in the price of A


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If Ec is between 0 and 1:quantityIf Ec is between 0 and 1:quantity

demanded of good B changes by ademanded of good B changes by a

smaller percentage than change in price ofsmaller percentage than change in price ofAA

If Ec if between one and infinity: quantityIf Ec if between one and infinity: quantity

demanded of good B changes by a largerdemanded of good B changes by a larger

percentage than the change in price of Apercentage than the change in price of A


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Substitute and Complement GoodsSubstitute and Complement Goods

The sign of Ec indicate whether the 2 goodsThe sign of Ec indicate whether the 2 goods

Considered are Substitutes or ComplementsConsidered are Substitutes or Complements

Ec is positive the substituesEc is positive the substitues

Ec is negative the complementsEc is negative the complements


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Complement GoodsComplement Goods

X axis QuantityX axis Quantity

Y axis Price of theY axis Price of the

related goodrelated good

Complemantar y goods

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0 0.5 1 1.5 2 2.5 3 3.5

quantity of good A

priceofgood

B

eries1


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Bread andBread and ButterButter

Razors and RazorbladesRazors and Razorblades

Vehicle and FuelVehicle and Fuel Television sets and VCRTelevision sets and VCR


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Substitute GoodsSubstitute Goods

X axis QuantityX axis Quantity

Y axis price of theY axis price of the

related goodsrelated goods

substitutes

0

5

10

15

20

25

0 0.5 1 1.5 2 2.5 3 3.5

quantity of good A

uantit

of

oo

d

B Series1


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Tea and CoffeeTea and Coffee

Rice and wheatRice and wheat

All FMCGsAll FMCGs


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SUPPLY

THE AMOUNT OF THE COMMODITY WHICH

THE SELLERS ARE ABLE AND WILLING TO OFFER

FOR SALE AT A PARTICULAR PRICE, DURING A

CERTAIN PERIOD OF TIME


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SUPPLY AND STOCKSUPPLY AND STOCK

1.1. SUPPLY COMES OUT OF STOCKSUPPLY COMES OUT OF STOCK

2.2. SUPPLY DETERMINES THESUPPLY DETERMINES THEPOTENTIALSTOCKPOTENTIALSTOCK

3.3. STOCK IS THE OUTCOME OFSTOCK IS THE OUTCOME OFPRODUCTIONPRODUCTION

4.4. RESERVATION PRICE AFFECTS THERESERVATION PRICE AFFECTS THE

RELEASE OF STOCK FOR THE FORRELEASE OF STOCK FOR THE FORTHE SUPPLY IN THE MARKETTHE SUPPLY IN THE MARKET


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SUPPLY SCHEDULESUPPLY SCHEDULE

AA TABLETABLE SHOWINGSHOWING THETHE QUANTITYQUANTITY

OFOF COMMODITYCOMMODITY SUPPLIEDSUPPLIED ATAT

VARIOUSVARIOUS PRICESPRICES DURINGDURING AA GIVENGIVEN

PERIODPERIOD

11.. INDIVIDUALINDIVIDUAL SUPPLYSUPPLY SCHEDULESCHEDULE

22.. MARKETMARKET SUPPLYSUPPLY SCHEDULESCHEDULE


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INDIVIDUALSUPPLY SCHEDULEINDIVIDUALSUPPLY SCHEDULE

PRICE OF COMMODITY QUANTITY SUPPLIED

10 200

12 300

15 500

18 700

20 1000


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MARKET SUPPLY SCHEDULEMARKET SUPPLY SCHEDULE

PRIC

E

PRODUCE

R A

PRODUCE

R B

PRODUCE

R C

TOTAL

SUPPLY

10 3 3 2 8

12 7 5 4 16

14 10 8 6 24

16 14 10 8 32

18 19 11 10 40


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SUPPLY CURVESUPPLY CURVE

PRICE

SUPPLY QUANTITY


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LAW OF SUPPLYLAW OF SUPPLY

OTHEROTHER THINGSTHINGS REMAININGREMAINING UNCHANGED,UNCHANGED,

THETHE SUPPLYSUPPLY OFOF AA COMMODITYCOMMODITY EXPANDSEXPANDS

WITHWITH AA RISERISE ININ ITSITS PRICEPRICE ANDAND CONTRACTSCONTRACTS

WITHWITH AA FALLFALL ININ ITSITS PRICEPRICE..


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OTHER THINGS REMAININGOTHER THINGS REMAINING

UNCHANGED

UNCHANGED

1.1. COST OF PRODUCTIONCOST OF PRODUCTION

2.2. NO CHANGE IN TECHNIQUE OFNO CHANGE IN TECHNIQUE OFPRODUCTIONPRODUCTION

3.3. FIXED SCALE OF PRODUCTIONFIXED SCALE OF PRODUCTION

4.4. GOVERNMENT POLICIES AREGOVERNMENT POLICIES AREUNCHANGEDUNCHANGED

5.5. NO SPECULATIONNO SPECULATION6.6. PRICES OF OTHER GOODS HELDPRICES OF OTHER GOODS HELD

CONSTANTCONSTANT


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ELASTICITY OF SUPPLYELASTICITY OF SUPPLY

ELASTICITYELASTICITY OFOF SUPPLYSUPPLY MAYMAY BEBE DEFINEDDEFINED ASAS

THETHE RATIORATIO OFOF THETHE PERCENTAGEPERCENTAGE CHANGECHANGE ININ

THETHE QUANTITYQUANTITY SUPPLIEDSUPPLIED TOTO THETHE

PERCENTAGEPERCENTAGE CHANGECHANGE ININ PRICEPRICE

PERCENTAGE CHANGE IN SUPPLY

ELASTICITY OF SUPPLY = --------------------------------------------------

PERCENTAGE CHANGE IN PRICE


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EXPANSION AND CONTRACTIONEXPANSION AND CONTRACTION

OFSU

PPLYOFSU

PPLY

QUANTITY SUPPLIEDQUANTITY SUPPLIED

PRICEPRICE

Q2Q2Q1Q1

P1P1

P2P2EXTENSIONEXTENSION

CONTRACTIONCONTRACTION


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INCREASE AND DECREASE OFINCREASE AND DECREASE OF

SU

PPLYSU

PPLY

QUANTITYQUANTITY

SUPPLIEDSUPPLIED

PRICEPRICE

Q3Q3Q2Q2Q1Q1

PP

S1S1

SS S2S2

INCREASEINCREASE

DECREASEDECREASE


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TYPES OF SUPPLYTYPES OF SUPPLY

ELAS

TICITYELAS

TICITY1. PERFECTLY INELASTIC SUPPLY1. PERFECTLY INELASTIC SUPPLY

2. PERFECTLY ELASTIC SUPPLY2. PERFECTLY ELASTIC SUPPLY

3. RELATIVELY INELASTIC3. RELATIVELY INELASTIC

4. RELATIVELY ELASTIC4. RELATIVELY ELASTIC

5. UNITARY ELASTIC5. UNITARY ELASTIC


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PERFECTLY INELASTIC ANDPERFECTLY INELASTIC AND

ELASTIC SUPPLYELASTIC SUPPLY

QUANTITYQUANTITY

PRICEPRICE

QQ

P1P1

P2P2

SS

QUANTITYQUANTITY

PRICEPRICE

PP SS


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RELATIVELY INELASTIC ANDRELATIVELY INELASTIC AND

ELASTIC SUPPLYELASTIC SUPPLY

QUANTITYQUANTITY

PRICEPRICE

P2P2

P1P1

Q1Q1 Q2Q2

SS

SS

P2P2

P1P1

Q1Q1 Q2Q2

QUANTITYQUANTITY

PRICEPRICE


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UNITARY ELASTICUNITARY ELASTIC

QUANTITYQUANTITY

PRICEPRICE

P2P2

P1P1

Q1Q1 Q2Q2

SS


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FACTORS DETERMININGFACTORS DETERMINING

ELAS

TICITY OFSU

PPLYELAS

TICITY OFSU

PPLY1. NATURE OF COMMODITY: PERISHABLE OR1. NATURE OF COMMODITY: PERISHABLE ORDURABLEDURABLE

2. TIME PERIOD: MARKET/ SHORT/ LONG2. TIME PERIOD: MARKET/ SHORT/ LONG

PERIODPERIOD

PRICE

QUANTITY

MARKET PERIOD

SHORT PERIOD

LONG PERIOD


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FACTORSFACTORS

4. SCALE OF PRODUCTION:4. SCALE OF PRODUCTION:

SMALLSCALESMALLSCALE-- R INELASTICR INELASTIC

LARGE SCALELARGE SCALE--ELASTICELASTIC

5. TECHNIQUE OF PRODUCTION:5. TECHNIQUE OF PRODUCTION:

ADVANCED TECH.ADVANCED TECH.-- R ELASTICR ELASTIC

6. SIZE OF FIRM, NO OF PRODUCTSPRODUCED6. SIZE OF FIRM, NO OF PRODUCTSPRODUCED

NO OF PRODUCTS: R ELASTICNO OF PRODUCTS: R ELASTIC

7. NATURAL FACTORS7. NATURAL FACTORS


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ELASTICITY AND OTHER

CONCEPTS OF ECONOMICS


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Elasticity of Demand

And Supply

Price Discrimination

Cross Subsidisation


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INELASTIC ELASTIC


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GIVERNMENT INTRODUCED FRINGEGIVERNMENT INTRODUCED FRINGE

BENEFIT, TAXBENEFIT, TAX

RISING INCOMERISING INCOME

DEMAND BECOMES ELASTICDEMAND BECOMES ELASTIC

THE INCOMES WERE REDUCED T0 LESSENTHE INCOMES WERE REDUCED T0 LESSEN

INFLATIONINFLATION

THUS WITH TAXATION, THERE WAS INCOMETHUS WITH TAXATION, THERE WAS INCOMEAND SUBSTITUTION EFFECTAND SUBSTITUTION EFFECT

Elasticity of Demand Indifference curve


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ELASTICITY OF DEMAND

AND SUPPLYBUSINESS CYCLES


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USES OF ELASTICITYUSES OF ELASTICITY

FOR MANAGERSFOR MANAGERS


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PRODUCTION

DECISION

PRICING

POLICY

TECHNOLOGY QUALITY

OF PRODUCT

EXPANSION AND

DIVERSIFICATION PLANS

MARKETING

STRATEGY

ELASTICITY OF DEMAND

AND SUPPLY


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STRATEGY EQUILIBRIUMOF ONE FIRM

STRATEGY EQUILIBRIUMOF OTHER FIRMS

GAME THEORY


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shortage Resolving chinas powershortage Resolving chinas power


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China power crisisChina power crisis

Key informationKey information

1. electricity consumption increases due to day1. electricity consumption increases due to daytemperature.temperature.

2. National wise shortage of electricity.2. National wise shortage of electricity.

3.order to suspend production and shift in3.order to suspend production and shift in

production time .production time .4.cut supply to suburban area.4.cut supply to suburban area.

5.thermal coal is the principle fuel .5.thermal coal is the principle fuel .

6 all transportation means were engaged to6 all transportation means were engaged tosupply coal.supply coal.

7.china is the world second bi est coal7.china is the world second bi est coal


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10.Spot market price of thermal coal increases by 25%.10.Spot market price of thermal coal increases by 25%.

11.Contract price increases by 10%.11.Contract price increases by 10%.12power plant cut back production12power plant cut back production

13. Supply shift toward sport market13. Supply shift toward sport market

14.Government increase electricity price 2.2 fens per14.Government increase electricity price 2.2 fens per

kw /hr.kw /hr.


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core problemcore problem

1 .shortage of electricity.1 .shortage of electricity.

2 Decreases in production due to decreases2 Decreases in production due to decreasesin supply of coal.in supply of coal.

3 Revenue loss of government.3 Revenue loss of government.

4 Manufacturing unit production hamper4 Manufacturing unit production hamper


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Effects of rising tempEffects of rising temp

1Demand ofelectricityincreases.1Demand ofelectricityincreases.

2Shortage ofelectricity2Shortage ofelectricity

3increases3increases in demand of gensate,solarplate (subsitution effect)in demand of gensate,solarplate (subsitution effect)

4 demand ofrefrigerators,coolers, Acincreases4 demand ofrefrigerators,coolers, Acincreases


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figfig

P

QO

Pe1

Qe1

D

S1

S2

g

Power supply decreasesPower supply decreasesPower supply decreasesPower supply decreases


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figfig

P

QO

Pe1

Pe3

Qe1

D

S1

S2

j g

k

Power shortagePower shortagePower shortagePower shortage

shortage

Qe2


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Effects of shortage of supplyEffects of shortage of supply

1 suspend in production of manufacturing unit.1 suspend in production of manufacturing unit.

2MNC company incurred revenue losses.2MNC company incurred revenue losses.

3Governement losses of revenue (manufacturing unit share3Governement losses of revenue (manufacturing unit share

is 65% in china's GDP)is 65% in china's GDP)4Agriculter in suburban area get irrigation hamper.4Agriculter in suburban area get irrigation hamper.

5production of other goods decreases.5production of other goods decreases.


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Effects of transportationEffects of transportation

1All meansoftransportations engagedinthermal coal supply.1All meansoftransportations engagedinthermal coal supply.

2Railway increasesfreight loadincreasestherevenueofrailway.2Railway increasesfreight loadincreasestherevenueofrailway.

3shipandroad engagementdecreasethesupply ofothergoodsin3shipandroad engagementdecreasethesupply ofothergoodsin

market.market.

4overseasaexportsalsodecreases4overseasaexportsalsodecreases


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Effects on exportEffects on export

1 Chinaisthesecond biggestcoal exporter1 Chinaisthesecond biggestcoal exporter

2cutinexportsofcoal totheextentof70 million..2cutinexportsofcoal totheextentof70 million..

3soitresultsinrevenue losses.3soitresultsinrevenue losses.


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Effects of spot market and contractEffects of spot market and contract

priceprice

1coal minesupply coal moretothespot market, sothatgenerates1coal minesupply coal moretothespot market, sothatgenerates

morerevenue.morerevenue.

2supply tothepowerplantdecreases.2supply tothepowerplantdecreases.

3thermal coal becomescostly soproductioncost.3thermal coal becomescostly soproductioncost.

4powerplantcuttheproduction.4powerplantcuttheproduction.

5 Governmentincreasestheprice2.2fenskw /hr.5 Governmentincreasestheprice2.2fenskw /hr.

6 powersectorandgovernment incurred revenue looses.6 powersectorandgovernment incurred revenue looses.

Shift i th lShift i th lShift i th lShift i th l


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figfig

P

QO

Power plant S0 Spot market

IncreaseDecrease

Shifts in the supply curveShifts in the supply curveShifts in the supply curveShifts in the supply curve


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Economic theory in this caseEconomic theory in this case

1electricity demand is relatively inelastic.1electricity demand is relatively inelastic.

2Demand of manufacturing unit is relatively more inelastic2Demand of manufacturing unit is relatively more inelastic

then house hold.then house hold.

3coal is the only key material for electricity ,so coal mines3coal is the only key material for electricity ,so coal mineshas monopoly.has monopoly.

4cross4cross--subsidisation.subsidisation.

5price discrimination.5price discrimination.

6 power plant operate according to marginal cost.6 power plant operate according to marginal cost.


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QO

MC

AC

Qm

MR

AR

AC

P max

Total pr

ofit

pricingpricing

pricingpricing

MR=MC


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Solution of the problemSolution of the problem

1 govt. should cut the supply to small1 govt. should cut the supply to small -- small area to smallsmall area to small

quantity rather then a large quantity in small area. Soquantity rather then a large quantity in small area. So

that supply could be equilibrium (load setting,that supply could be equilibrium (load setting,

2 peak distribution to house hold (day time).2 peak distribution to house hold (day time).

3 off peak distribution to industries.3 off peak distribution to industries.

large quantity, small area small quantity,large quantity, small area small quantity,

small small areasmall small area


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P fitP fit i i i t t di i i t t dP fitP fit i i i t t di i i t t d


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figfig

O O O

MRX

MRY MRT

MC

DY

57

1000 2000 3000

industries House holds (c) Total

(markets X + Y)

9

DX

ProfitProfit--maximising output undermaximising output under

price discriminationprice discrimination

ProfitProfit--maximising output undermaximising output under

price discriminationprice discrimination


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TR

Cost / Revenue

Output/Sales

Output/Sales

D = AR

MR

TC

MC

Q1 Q2

Putting the two together:

Ifafirm wastotarget

revenue maximisation

asanobjective, this

wouldnotnecessarily

correlate withtheprofit

maximisingoutput

revenue maximisationoccurs where TRisata

maximum (MR = 0)


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Government can give subsidyGovernment can give subsidy


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cross elasticity 1

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