Elasticity shows how sensitive quantity is to a change in price. Copyright ACDC Leadership 2015

Consumers will buy more when prices go down and less when prices go up THE LAW OF DEMAND SAYS... Consumers will buy more when prices go down and less when prices go up HOW MUCH MORE OR LESS? DOES IT MATTER? Copyright ACDC Leadership 2015

Price Elasticity of Demand (PED) Measurement of consumers responsiveness to a change in price. What will happen if price increase? How much will it effect Quantity Demanded Who cares? Used by firms to help determine prices and sales Used by the government to decide how to tax Copyright ACDC Leadership 2015

Inelastic Demand Copyright ACDC Leadership 2015

Inelastic Demand INelastic Demand= Quantity is INsensitive to a change in price. If price increases, quantity demanded will fall a little If price decreases, quantity demanded increases a little. In other words, people will continue to buy it. 20% 5% A INELASTIC demand curve is steep! (looks like an “I”) Examples: Gasoline Milk Diapers Chewing Gum Medical Care Toilet paper Copyright ACDC Leadership 2015

General Characteristics of INelastic Goods: Inelastic Demand General Characteristics of INelastic Goods: Few Substitutes Necessities Small portion of income Required now, rather than later Elasticity coefficient less than 1 20% 5% Copyright ACDC Leadership 2015

Elastic Demand Copyright ACDC Leadership 2015

Elastic Demand An ELASTIC demand curve is flat! Elastic Demand = Quantity is sensitive to a change in price. If price increases, quantity demanded will fall a lot If price decreases, quantity demanded increases a lot. In other words, the amount people buy is sensitive to price. An ELASTIC demand curve is flat! Examples: Soda Boats Beef Real Estate Pizza Gold Copyright ACDC Leadership 2015

General Characteristics of Elastic Goods: Elastic Demand General Characteristics of Elastic Goods: Many Substitutes Luxuries Large portion of income Plenty of time to decide Elasticity coefficient greater than 1 Copyright ACDC Leadership 2015

Elastic or Inelastic? What about the demand for insulin for diabetics? Beef- Gasoline- Real Estate- Medical Care- Electricity- Gold- Elastic- 1.27 INelastic - .20 Elastic- 1.60 INelastic - .31 INelastic - .13 Elastic - 2.6 What if % change in quantity demanded equals % change in price? Perfectly INELASTIC (Coefficient = 0) Unit Elastic (Coefficient =1) Copyright ACDC Leadership 2015

Elasticity Visualized Perfectly Inelastic Elasticity Coefficient 0 Relatively Inelastic Elasticity Coefficient <1 Unit Elastic Elasticity Coefficient1 Relatively Elastic Elasticity Coefficient >1 Perfectly Elastic Elasticity Coefficient ∞ Copyright ACDC Leadership 2015

Total Revenue (P x Q) Relatively Inelastic Relatively Elastic S1 S1 S S D D What happens to quantity for each when price increases? What happens to total revenue for each when price increases? Copyright ACDC Leadership 2015

Total Revenue Test Uses elasticity to show how changes in price will affect total revenue (TR). Ex: If the demand for gas is inelastic, what will happen to total revenue for gas stations if price increases? Inelastic Demand- Price increase causes TR to increase Price decrease causes TR to decrease Elastic Demand- Price increase causes TR to decrease Price decrease causes TR to increase Unit Elastic- Price changes and TR remains unchanged Copyright ACDC Leadership 2015

Is the range between A and B, elastic, inelastic, or unit elastic? 10 x 100 =$1000 Total Revenue 5 x 225 =$1125 Total Revenue A Price decreased and TR increased, so… Demand is ELASTIC 50% B 125% Copyright ACDC Leadership 2015

Copyright ACDC Leadership 2015

Other Types of Elasticity Cross-Price Elasticity of Demand Income Elasticity of Demand Price Elasticity of Supply

Cross-Price Elasticity of Demand Cross-Price elasticity of demand shows how sensitive a product is to a change in price of another good It shows if two goods are substitutes or complements % change in quantity of product “b” % change in price of product “a” P increases 20% Q increases 40% Q decreases 40% If coefficient is positive (shows direct relationship) then the goods are substitutes If coefficient is negative (shows inverse relationship) then the goods are complements Copyright ACDC Leadership 2015

2008 udit Question 34

2010 Question 6 Copyright ACDC Leadership 2015

Income-Elasticity of Demand Income elasticity of demand shows how sensitive a product is to a change in INCOME It shows if goods are normal or inferior % change in quantity % change in income Income increases 20%, and quantity decreases 15% then the good is a… INFERIOR GOOD If coefficient is positive (shows direct relationship) then the good is normal If coefficient is negative (shows inverse relationship) then the good is inferior Ex: If income falls 10% and quantity falls 20%… Copyright ACDC Leadership 2015

Practice Questions 1. If the cross price elasticity coefficient of goods A and B is -5 and the income elasticity of good A is 2, which of the following is true? A decrease in the price of good A will decrease the demand for good B An increase in income will decrease the demand for good A Goods A and B are substitutes Good B is an inferior good An increase in the price of A will decrease the demand for good B Copyright ACDC Leadership 2015

Price Elasticity of Supply Elasticity of supply shows how sensitive producers are to a change in price. Elasticity of supply is based on time limitations. Producers need time to produce more. INelastic = Insensitive to a change in price (Steep curve) Most goods have INelastic supply in the short-run Elastic = Sensitive to a change in price (Flat curve) Most goods have elastic supply in the long-run Perfectly Inelastic Supply= Q doesn’t change Set quantity supplied (Vertical line) Copyright ACDC Leadership 2015

Practice Questions 1. Which of the following must be true for original Michelangelo sculptures? The demand is relatively elastic The supply is perfectly elastic The demand is perfectly inelastic The supply is perfectly inelastic The demand is perfectly elastic Copyright ACDC Leadership 2015