Elasticity

Measures “responsiveness” to change in price

(Measures a Movement; Price Effect)

Price Elasticity of Demand

Sensitivity of quantity demanded to price changes

Elastic: Small P-change, large Q-demanded change

Inelastic: Large P-change, small Q-demanded change

Elastic, Inelastic

Elastic – E(d) > 1 Inelastic – E(d) < 1 Perfect Inelastic – completely price

Insensitive – E(d) = 0 Perfect Elastic – Completely Price Sensitive

– E(d) = infinite

Coefficient of Price Elasticity

To determine how elastic a product is, in other words, how demand for that product will be affected by a change in price, use the following equation.

E(d) = ( QD/QD) / ( P/P) Allows us to compare across markets and

other goods

Practice

Starting at Price P1 = 20, Quantity Q1 = 200 Price goes to P2 = 24, Quantity Q2 = 180

P1 = 20 Q1 = 200 P2 = 24 Q2 =180

[(180-200)/200] / [(24-20)/20](20/200) / (4/20) = .1/.2E(d) = .5

Elasticity and Demand Curves

Example: 10% Price Increase

D Inelastic [E(d) < 1] QD decrease less than

P increase D Elastic [E(d) > 1]

QD decreases more than price increase

Elasticity and Demand Curves

0

20

40

60

80

1 2 3 4 5

Quatntity DemanedPr

ice Inelastice

Elastic

P1 = 40 P2 = 44

QD for each curve?

Practice

Determine the Elasticity.

P1 = 2 P2 = 4

Demand

0

2

4

6

1 2 3 4 5

Quantity Demanded

Pric

e

Demand

Practice

Determine the Elasticity. P1 = 100 P2 = 200

Demand

050100150200250

1 2 3 4 5

Quantity Demanded

Pric

e

Demand

Example

Reaction to raise in price of cigarettes by Teenagers and Adults.

Teenagers Adults

Why is there a greater reaction from the teenagers?

Perfectly/Inelastic Demand

Perfectly Inelastic: QD is unresponsive tp P change Draw a demand curve that displays Perfect Inelasticity. Examples

Perfectly Elastic: QD totally responsive to P change Draw a demand curve that displays Perfect Elasticity. P-increase: QD = 0 P-decrease: buyers buy all they want Examples

The Elasticity of a good’s demand tends to increase with:

Number of closes substitutes.

If there are 10 brands of bicycles available and the prices for one of them increase, the quantity of that brand demanded is likely to fall a lot.

Elasticity (Cont.)

The proportion of income spent on the good.

Consider gum and cruise price-change scenarios. The quantity of cruises purchased will probably be more affected by a 50% price increase than the quantity of bubble gum because an extra 2 cents is not a big deal but an extra $500 is more likely to be prohibitive.

Elasticity (Cont.)

Time When time is short, it is more difficult to

change purchasing patterns in response to changes. The more time consumers have to adapt, the more they are able to find substitutes or learn to do without goods whose prices have increased.

Elasticity (Cont.)

The lack of importance of a good The less essential a good is, the more likely

consumers are to forego the good when it becomes more expensive.

Luxuries v. Necessities

Goods with an elastic demand are categorized as luxuries.

Goods with an inelastic demand are categorized as necessities.

Why should a business care about the elasticity of demand?

One reason is that the elasticity determines what happens to revenue when price changes.

Revenue = Price x Quantity When facing a inelastic demand, to bring in more revenue

while selling fewer units, raise the price of the good.