Examination Tips
HKCEE F 4 Economics
Topic
5: Price elasticity of Demand & Supply
In topic 3, we can see how a
decrease in price leads to increase in
Quantity demanded, according to law of demand but we don’t
Consider the responsiveness of the quantity demand of a good,
to the change in its price. This chapter starts with that field and
then, consider the relationship between price elasticity of demand
and total revenue and, is closed with factors affecting price
elasticity of demand and supply.
Topic 5 is very important
in public examination and should
be studied together with
topic 3 and topic 4 because questions
always examine students
how total revenue changes due to
changes in demand and
supply which give rise to changes
in price and quantity
transacted.
Topic 5 should
be also studied with Topic 6: market intervention
since the extent of distribution of tax and subsidy
between
buyers and sellers is dependent of the price
elasticity of
demand and supply.
5.1. Price Elasticity of Demand**
(1) Definition
It refers to the responsiveness
of the quantity
Demand of a good, to the
change in its price.
(2)
The formula of measuring price elasticity of demand ( Ed )
(3) The
example
Price D
Quantity of
clothes
Figure
1 A demand curve for clothes
Suppose the
price of clothes decreases
By 10% (figure
1) , quantity
Demanded
increases by 20%.
Applying the
above formula, the price
Elasticity of
demand along this price
Range is:
= 20 %
- 10 %
= -2
(4) Note on price elasticity of demand
Owing to downward sloping demand curve,
Price and quantity
demanded is negatively
Related. Thus, the price elasticity of demand
Is negative.
However, we take its absolute value. This means
if we talk about low Elasticity, we say
low in
absolute value and ignore the
minus sign “-”.
5.2. Methods of measuring price elasticity of demand**
There are two methods of measuring the price
Elasticity of demand;
that is: the original price
And quantity method and the average price
and quantity method ( arc elasticity of Demand )
(1) The original price and
quantity method
The
original price and quantity method has
been used to calculate the price elasticity of
demand in 5.1.
However, there is the problem
of finding out
the same value of Ed when the
price is
reversed.
Price D
$30
$20
60 80 Quantity of clothes
Figure
2 A demand curve for clothes
Suppose price
increases from $20 to $30,
Quantity demanded
will decrease from
80 to 60. The
price elasticity of demand
along this price
range is:
= -25%
50 %
= -0.5.
(2) Average price and quantity
method
In order to
avoid the problem in using the original
Price and quantity
method, we use the average
Price and
quantity method
(a) The formula
(b) The example
Price D
$30
$20
60 80 Quantity of clothes
Figure 3 A demand curve for clothes
Suppose
the price increase from $20 to $30,
its
quantity demanded will decrease from
80 to 60.
Applying the above formula,
the price
elasticity of demand is:
= -20 X $50/2
+$10
140/2
= -0.72.
Suppose
the price decreases from $30 to $20,
its
quantity demanded will increase from
60 to 80.
Applying the above formula,
the price
elasticity of demand is:
= +20
$50/2
-$10
140/2
= -0.72.
Therefore, we
can calculate the same value
Of price
elasticity of demand, whether the
Price will
increase or decrease.
Examination Tips On 5.1 and 5.2
1. Examination Records
(a) In paper 1, there was no question of
examining
Merely the concept of price elasticity of demand
(Ed) and two methods of calculating Ed
(b) In paper 2, students were asked to
calculate
The price elasticity of demand, given the
Available data.
2. Study Guide
Bear in
mind that when calculating Ed, please
Adopt the
average price and quantity method
In order
to avoid the problem of using the
Original
price and quantity method.
5.3. Types of Price elasticity of demand**
(1) Elastic Demand
(a) Definition
The percentage change in quantity demanded
Is greater than the percentage change in price.
This means that:
(b) Values of
price elasticity of demand
Ed is greater than one
(2) Inelastic Demand
(a) Definition
The percentage change in quantity demanded
Is lower than the percentage change in price.
This means that:
(b) Values of
price elasticity of demand
Ed is less than one
(3) Perfectly elastic Demand
(a) Definition
A small percentage change in price
Will result in an infinitely large
Change in quantity demanded.
This means that:
(b) Values of price
elasticity of demand
Ed is ∞.
(c) Graphic
presentation
Price
D
0 Quantity
Figure
4 perfectly elastic demand curve
(4) Perfectly inelastic Demand
(a) Definition
Any change in price will not result in
any change in quantity demanded.
This means that:
(b) Values of price
elasticity of demand
Ed
is 0.
(c) Graphic
presentation
Price
D
0
Quantity
Figure 5 Perfectly inelastic demand
curve
(5) Unitarily elastic Demand
(a) Definition
Any change in price will result in
Same percentage change in quantity demanded.
This means that:
(b) Values of price elasticity of demand
Ed is 1.
(c) Graphic presentation
Price
0
Quantity
Figure
6 Unitarily elastic demand curve
Examination Tips on 5.3:
(1) Examination Records
No question set on this section in paper 1
(2) Study Guide
Though there is no
question set on this section in paper 1,
Students were asked to explain why total revenue increases
Or
decreases, as given information about which type of price
elasticity of demand is. Make sure that you understand each
type
of Ed with aids of diagrams.
5.4. The relationship between price elasticity
of demand and total Revenue*****
(92, 93, 96, 97,
98, 00)
(1) What is total revenue?
Price D
S
P1
S
D
0
Quantity
Q1
Figure 7 Graphical measure of
total revenue
Total revenue is the
seller’s total receipt of
Selling
good or services. It refers to
The market price of good or services
(P1)
multiplied by the quantity transacted
(Q1) in figure 7.
(2) Elastic Demand and Total Revenue
(a) When the price decreases, total revenue increases
Price D
P0
Loss
Gain
P1
D
0
Q1
Q2
Quantity
Figure 8 Effect of
a decrease in price on an elastic range of demand curve
The reason
why total revenue increases after the decrease
In price
is because the percentage increase in quantity
Demanded (
gain in revenue in figure 8) is greater
than the
percentage decrease in price ( loss in revenue
in figure
8).
This
means:
(b) When the price increases, total revenue decreases
The
reason why total revenue decreases after the increase
In
price is because the percentage decrease in quantity
Demanded ( loss in revenue ) is greater than the
percentage increase in price ( gain in revenue).
This
means:
(3) Inelastic Demand and Total Revenue
(a) When the price increases, total revenue increases
Price
loss
D
0
Quantity
Figure 9 Effects of an increase in price on an inelastic range of demand
curve
The reason
why total revenue increases after the increase
In price
is because the percentage decrease in quantity
Demanded (
loss in revenue in figure 9 ) is less
than the
percentage increase in price ( gain in revenue
in figure
9).
This
means:
(b) When the price decreases, total revenue decreases
The
reason why total revenue decreases after the decrease
In
price is because the percentage increase in quantity
Demanded (gain in revenue ) is less than the
percentage decrease in price ( loss in revenue).
This
means:
(4) Unitarily Elastic Demand and Total
Revenue
Price
0
Quantity
Figure 10 A unitarily elastic demand curve
When the price increases or decreases,
total revenue remain unchanged
The reason why
total revenue remain unchanged
because the
percentage increase (decrease) in
quantity demanded is equal to the percentage
decrease
(increase) in price. In Figure 10, the
unitarily elastic demand curve represents
the
same rectangles
which show that total revenue
is the same,
when the price changes.
This means:
Examination Tips
on 5.4
1. Examination Records
(a) Students were examined how total revenue
changed
When supply of or demand for good changed.
(b) Students were asked to explain how total
revenue changed
When the price of good changed due to depreciation of
Foreign currency or a decrease in price of its
substitutes.
2. Student’s
weakness on CE
(a)
Students did not know the question was involved
with the elasticity of demand.
(b)
Students failed to explain the change in total
Revenue by
comparing the percentage change
In price
and the percentage change in quantity
Demanded.
(c)
They did not know how to explain the concept of
both inelastic demand and elastic demand.
3. Study
Guide
(a) bear in mind that whether a change in total
revenue is
related with the price elasticity of demand depends on
the direction of change in price and quantity
demanded.
If the price and quantity demanded changes in same
Direction, a change in total revenue is involved with
The price elasticity of demand. If price and quantity
Demanded change in reverse way, there is no
Relationship between Ed and total revenue.
(b) If total revenue is related with Ed, please
analyze
The information given by the questions to decide
The direction of changes in price and quantity
Transacted. In some cases, price and quantity
transacted will change in reverse way due to
change in supply, depreciation of foreign
currency and price-cut.
(c) If total revenue is not related with Ed,
please
Analyze the information given by the questions
To decide the direction of changes in price and
Quantity transacted. In some cases, price and
quantity transacted of good will change in same
direction due to change in price of its substitutes,
change in demand and under the excess demand
situation.
(d) If
total revenue is not related with Ed, we should also
consider the price elasticity of supply. If we understand
supply is perfectly inelastic from the information
given by the questions, quantity transacted will
remain unchanged, although price changes. Then, we
are able to determine the direction of change in total
revenue and avoid mistakenly considering the price
elasticity of demand that is involved in change in
total revenue.
(e) This section
should be studied with Topic 6: market
intervention since the extent of distribution of tax and
subsidy between buyers and sellers is dependent of
the price
elasticity of demand and supply.
5.5. Factors affecting price
elasticity of demand**
(1) Availability of
substitutes
Demand for a good will be more elastic if there are
More substitutes. This is because when the price
Of a good increases, people can easily switch to
Its substitutes.
(2) Time for adjustment
Demand for a good may be inelastic in short run,
But elastic in long run if the price of a good
increases. This is because people need time to
adjust their consumption pattern. When there
is more time for consumer to find substitutes of
a good, elasticity of demand will be higher.
(3) Proportion of consumer’s
income spent on a good
If the good,
salt, takes up a small proportion of
Consumer’s
budget. Increase in price will have
Little effect on
consumer’s budget. Consumers
can pay more for
salt. Elasticity of demand
Of salt is low.
(4)
Consumption habit
If consumers
have a habit of consuming one
Good, demand
elasticity for that good is
Low.
(5)
Degree of necessity
If the good is
necessity, demand elasticity for
That good is
lower. If the good is luxury,
demand
elasticity for that good is higher.
Examination Tips on 5.5
1. Examination Records
(a) No
questions set on this section in paper 1.
(b) No
questions set on this section in paper 2.
2. Study guide
Understand
each factor affecting price elasticity
Of demand
is enough
5.6. The price elasticity of Supply
(1) Definition
It refers to the responsiveness
of the quantity
Supplied of a good, to the
change in its price.
(2)
The formula of measuring price elasticity of supply ( Es )
(3)
The example
Price
s
0
Quantity
of clothes
Figure 11 a supply curve for clothes
Suppose the
price of clothes increases
By 10% (figure
11) , quantity supplied
increases by
20%. Applying the above
formula, the
price elasticity of supply
along this price
range is:
= 20 %
10 %
= 2
5.7. Methods of measuring price elasticity of Supply**
There are two methods of measuring the price
Elasticity of supply;
that is: the original price
And quantity method
and the average price
And quantity method (
arc elasticity of
supply )
(1) The original price and
quantity method
This
method has been used in Section
5.6.
However, similar to the original price
Price and
quantity method used for
Measuring
price elasticity of demand,
There is the problem
of finding out
The same
value of price elasticity
Of supply
when prices are reversed.
(2) Average price and
quantity method
In order
to avoid the problem in using the original
Price and
quantity method, we use the average
Price and
quantity method
(a) The formula
(b) The example
Price
s
$30
$20
0
60 80
Quantity
of clothes
Figure 12 a supply curve for clothes
Suppose
the price increases from $20 to $30,
its
quantity supplied will increase from
60 to 80.
Applying the above formula,
the price
elasticity of supply is:
= 20
$50/2
$10
140/2
= 0.72.
Suppose
the price decreases from $30 to $20,
its
quantity supplied will decrease from
80 to 60.
Applying the above formula,
the price
elasticity of supply is:
= 20
$50/2
$10
140/2
= 0.72.
Therefore, we
can calculate the same value
Of price
elasticity of supply, whether the
Price will
increase or decrease.
Examination Tips on 5.7
1.
Examination Records
There
is no questions set on 5.7 in paper 1
2.
Study guide
Understanding
how to calculate the price elasticity
Of supply by
the above two methods is enough.
5.8. Types of Price elasticity of Supply****(91, 92, 95 )
(1) Elastic Supply
(a)
Definition
Increase(decrease) in price will result in
a
Larger percentage increase (decrease) in
quantity supplied.
This means that:
(b) Values
of price elasticity of supply
Es is greater than one
(c)
Graphic Presentation
Price
S
0 Quantity
Figure 13 an elastic supply curve
(2) Inelastic supply
(a) Definition
Increase (decrease ) in price will lead to
A smaller percentage Increase( decrease )
In quantity supplied.
This means that:
(b) Values of
price elasticity of supply
Es is less than one
(c) Graphic
Presentation
S
Price
0 Quantity
Figure
14 an inelastic supply curve
(3)
Perfectly elastic supply
(a) Definition
A small percentage change in price
Will result in an infinitely large
Change in quantity supplied.
This means that:
(b) Values of
price elasticity of supply
Es is ∞.
(c) Graphic
presentation
Price
s
0 Quantity
Figure
15 perfectly elastic supply curve
(4) Perfectly inelastic supply
(a) Definition
Any change in price will not result in
any change in quantity supplied.
This means that:
(b) Values of
price elasticity of supply
Es is 0.
(c) Graphic
presentation
Price
s
0
Quantity
Figure 16 perfectly inelastic
supply curve
(5)
Unitarily elastic supply
(a) Definition
Any change in price will result in
Same percentage change in
quantity supplied.
This means that:
(b) Values of
price elasticity of supply
Es is 1.
(c) Graphic Presentation
Price
s
0 Quantity
Figure 17 unitarily elastic supply curve
Examination Tips on 5.8
1. Examination Records
(a) Student were examined to explain how the price
And total revenue change after raising the fee, under
perfectly elastic Supply and excess demand conditions.
(b)
Student were asked to draw the type of supply curve,
Based on the information about taxi licenses given by
the question.
(c)
Students were asked to draw the type of supply curve,
According the information about the rental
accommodation
In USA given by the question.
2. Student’s
Weakness
(a)
good performance about drawing a supply curve of taxi licenses
(b)
good performance about drawing a supply curve of rental
accommodation in USA.
3. Study guide
(a)
To decide which type of price elasticity of supply, you should
analyze the key words of the questions, like “fixed supply.”
Or “supply is fixed”.
(b)
This section should be studied together with Topic 6: market
intervention because the extent of distribution of subsidy and
taxes is dependent of the price elasticity of supply and demand.
(c) If
change in total revenue is not related with Ed, we should also
consider the price elasticity of supply. If we understand
supply is perfectly inelastic from the information
given by the questions, quantity transacted will
remain unchanged, although price changes. Then, we
are able to determine the direction of change in total
revenue and avoid mistakenly considering the price
elasticity of demand that is involved in change in
total revenue.
5.9. Factors affecting price
elasticity of supply*
(1) Mobility of factor
inputs
If factor inputs are occupationally mobile,
This means they can work for one job to
Another job easily.
Producers can easily adjust factor input’s
Production capacity. Therefore, elasticity
Supply will be higher.
(2) Time factor
Elasticity of supply will be lower during short
Period of time. This is because producers cannot
Easily expand the production capacity.
However, during long period of time, they
Can install more capital goods and labour.
The production capacity will be larger and
Elasticity of supply will be higher during
Long period of time.
(3) entry of producers
If the new producers
can easily entry
The market, the
elasticity of supply
Will be higher. This
is because if
The price of a good
increase, the
Production of both new
and old
Producers will
increase.
(4)
Production method
If products
require labour-intensive method,
The elasticity
of supply will be higher. This
Is because the
production capacity can be
Easily expanded
by employing more labour.
If products
require capital intensive method,
The elasticity
of supply will be lower. This
Is because it is
time-consuming to install
Capital goods
and the production capacity
Cannot be easily
expanded.
Examination Tips on 5.9
1. Examination Records
There is no question set on this section in paper 1
and
Paper 2.
2. Study Guide
Understanding each factor affecting price elasticity
of supply
Is enough.