Chapter 3, Section 3

 Understand the concepts of elastic, inelastic, and unit-elastic demand  Be able to make elasticity calculations  Know the factors that affect the elasticity of demand for a given product  Learn how to maximize revenue using elasticity calculations

 Elasticity of demand shows the relationship between a change in price and quantity demanded (Q d )  Elastic Demand—percentage change in Q d is greater than the percentage change in price  Inelastic—percentage change in Q d is less than the percentage change in price  Unit-Elastic—percentages are equal  Formula: Elasticity = % change in Q d divided by % change in price

 (1) Bill raises the price of lettuce 20%, and the quantity demanded falls by 40%. What is the elasticity of demand? .40 divided by.20 = 2  Because the result is >1, demand is elastic  Joe raises the price of CDs from $5 to $10, and the quantity demanded falls from 200 units to 50 units. What is the elasticity of demand?  % change in Qd = New quantity – old quantity/old quantity … /200 = /200 = (75% reduction in Q d )  % change in price = new price – old price/old price … $10-5/5 = 5/5 = 1 (100% increase in price)  Elasticity = /1 =.75 (demand is inelastic)

 (1) Number of Substitutes—if there are more close substitutes for a product … would quantity demanded for that product tend to be more elastic or inelastic?  More close substitutes = more elastic  Patented medication (no competition) vs. soft drinks—for which is demand likely to be more elastic?  (2) Luxuries vs. Necessities—which tends to be more elastic?  Luxuries!

 (3) Percentage of Income Spent—the bigger percentage a given product takes from your income, the more sensitive you are to changes in its price  Example: if you spend $2 a month on gum and $200 a month on music, a change in the price of which one would have a greater impact on your behavior?  (4) Time—the longer the time frame, the more elastic quantity demanded tends to be (people adapt over time)  Example: Price of electricity goes up 20%. You might not make immediate changes, but over the course of the winter, you might make more

 Why is it important for sellers to understand elasticity of demand?  Because it tells them whether to raise or lower prices to maximize revenues!  If demand is elastic and price increases … what happens to revenue?  It decreases!  If demand is elastic and price decreases … what happens to revenue?  It increases!  The opposite is true for inelastic demand.  See examples on p. 105

 Butch currently sells 100 turkeys a day at $5 each. When he raises the price to $6 each, he only sells 60 turkeys.  What is the total revenue for each price/Q d combination?  Is demand elastic or inelastic?  Should Butch keep selling turkeys at the higher price, or go back to selling at the lower price?