Chap. 4 Sect. 3 Elasticity of Demand Goals: Explain “elasticity of demand” and provide examples of an elastic and inelastic good. Identify the factors that can affect elasticity. Explain how firms use elasticity and revenue to make decisions.

Elasticity of Demand The measurement of how consumers react to a change in price – How much does the price affect their demand for the item? The elasticity of a good depends on the original price of a good and how important it is to the buyer. Buyers are willing to pay higher prices for something they value more, and walk away from something they think is worth less than the asking price.

Elastic vs. Inelastic Elastic Demand – when a small price increase for an item greatly reduces the demand for that item. Examples? Inelastic Demand – when a price increase only reduces demand by a small amount or not at all. Examples? Elasticity of a good can vary at different price levels. 50% increase of a good valued at $1.00 =Inelastic 50% of the same good valued at $3.00 = Elastic

Small change in price = big change in demand Elastic Demand Curve Small change in price = big change in demand Price goes from $3 to $4 = 33 % Qty Demanded from 20 to 10 = 50 % Small in price= Big in demand and Price 5 10 15 20 25 30 Quantity

Inelastic Demand Curve Big change in price = small change in demand Price goes from $2 to $6=300% Qty Demanded from 15 to 10 = 33% Big in price = small in demand And Big in price = small in demand Price 5 10 15 20 25 30 Quantity

4 Factors Affecting Elasticity Availability of Substitutes – the greater the # of substitutes then the greater the elasticity of demand. 2. Relative importance – how much of your budget is spent on the good. clothing vs. shoelaces 3. Necessities vs. Luxuries – the more necessary the good is, the more inelastic it is, if it is seen as a luxury it is more elastic bread/milk vs. steak 4. Change over time – the longer the price stays high, the more likely people will find a substitute or make do without.

4 Factors Affecting Elasticity

Elasticity and Revenue Total Revenue – The total amount of money a company receives from selling its G & S. Why would a business want to know whether the demand for its good was elastic or not? The elasticity of demand determines how a price change will affect the company’s total revenue. Raising the price of a good w/elastic demand = big change in revenue Raising the price of a good w/inelastic demand = little change in revenue