Chapter 4.3 notes

Demand ElasticityDemand Elasticity

Demand Elasticity

• HOW MUCH a change in P causes a HOW MUCH a change in P causes a change in Qdchange in Qd

• ElasticElastic – when a change in P causes a – when a change in P causes a relatively larger relatively larger change in Qd. Ex: green change in Qd. Ex: green beans, corn, tomatoes, etc. beans, corn, tomatoes, etc.

cont’d

• InelasticInelastic – a change in P causes a – a change in P causes a relatively smaller relatively smaller change in the quantity change in the quantity demanded. Ex: table salt, gasdemanded. Ex: table salt, gas

• Unit Elastic Unit Elastic – a given change in price – a given change in price causes a causes a proportional proportional change in quantity change in quantity demanded.demanded.

Calculating Demand Elasticity

Demand Elasticity = Demand Elasticity = %%ΔΔQdQd

%%ΔΔPP

If the numerator is > denominator = elasticIf the numerator is > denominator = elastic

If the denominator is > numerator = inelasticIf the denominator is > numerator = inelastic

Total Expenditures Test• TE= TE= P x QdP x Qd• If demand curve is If demand curve is elasticelastic – when P down, – when P down,

TE up. (inverse)TE up. (inverse)• If the demand curve is If the demand curve is inelasticinelastic – P down, – P down,

TE down and vice versaTE down and vice versa• If the demand curve is If the demand curve is unit elasticunit elastic – P down – P down

OR up and NO change in TEOR up and NO change in TE

Total Expenditure

Demand

Quantity

Q

P

0

Price

P × Q = $400(TE)

$4

100

When the price is $4, consumers will demand 100 units, and spend $400 on this good.

How TE Changes When Price Changes: Inelastic Demand

Demand

Quantity0

Price

TE = $100

Quantity0

Price

TE = $240

Demand$1

100

$3

80

An Increase in price from $1 to $3 …

… leads to an Increase in TE from $100 to $240

How TE Changes When Price Changes: Elastic Demand

Demand

Quantity0

Price

TE = $200

$4

50

Demand

Quantity0

Price

TE = $100

$5

20

An Increase in price from $4 to $5 …

… leads to an decrease in TE from $200 to $100

Note that with each price increase, the Law of Demand still holds – an increase in price leads to a decrease in the quantity demanded. It is the change in TR that varies!

Determinants of D Elasticity

• Necessities vs. Luxuries – Necessities Necessities vs. Luxuries – Necessities usually inelasticusually inelastic

• Substitutes goods/services - If no sub, Substitutes goods/services - If no sub, usually inelasticusually inelastic

• Portion of income – if uses a large portion Portion of income – if uses a large portion of income, usually elasticof income, usually elastic

Rank the following items from most elastic to least elastic

• Honda AccordHonda Accord

• BeefBeef

• European vacationEuropean vacation

• SaltSalt

• Dijon mustardDijon mustard

• steaksteak

Results…?

• European VacationEuropean Vacation

• Honda AccordHonda Accord

• Dijon mustardDijon mustard

• SteakSteak

• BeefBeef

• saltsalt