RESPONDING TO PRICE CHANGES (ELASTICITY OF DEMAND & SUPPLY) Lesson 2.5

RESPONDING TO PRICE CHANGES (ELASTICITY OF DEMAND & SUPPLY)

Lesson 2.5

The Law of Demand

The quantity demanded varies inversely with price, other things constant (a.k.a. Price Effect)

Price = Quantity demanded

Price = Quantity demanded

Elasticity of Demand

Law of Demand does not specify the degree to which the quantity demanded will change.

Degree of Change = QD vs. Price Changes

Demand is elastic if QD changes significantly as price changes.

Demand is inelastic if QD changes little as price changes.

Red Bull

If price of Red Bull increased from $2.00 to $2.50, would you still purchase from the vending machine?

At what price would you change your behavior? This is price elasticity – how producers and

consumers react to a change in price.

Elastic vs. Inelastic

Rubber Band – doesn’t take much effort to change its shape. This means you are RESPONSIVE to price changes (elasticity).

Pencil – takes much more effort to break the pencil than to change the shape of a rubber band. This means you are not RESPONSIVE to price changes (inelastic).

Estimating Elasticity

Salt – no substitutes, small portion of income, and a necessity. All of these say that SALT is considered INELASTIC.

Sports Car – substitutes available, large portion of your income, and a luxury item. All of these say that a SPORTS CAR is considered ELASTIC.

Handouts

Elasticity Scenarios Will quantity demanded be elastic or

inelastic? Which factors play a role? Justify your decisions with sound

economic reasoning.

Demand Curves

Why do the curves look different? Talk to those around you and determine

why they look different?

Price elasticity can be zero if someone won’t buy a product. Reasons: cultural, health, environmental,

political, moral, etc.

Inelastic Demand

Price change has little or no effect on QD.

Line will be steep!

Elastic Demand

Price change has a huge change on QD.

Line will be more gradual!

Total Revenue Test

Elasticity of Demand I will help you with the first one.

Elastic Demand Inelastic Demand

When P in, demand decreases When P increases, D stays the same

There are substitutes Few substitutes for good or services

Want Need