[ 3.3 ] Elasticity of Demand

[ 3.3 ] Elasticity of Demand Learning Objectives Explain how to calculate elasticity of demand. Identify factors that affect elasticity of demand. Explain how firms use elasticity and revenue to make decisions.

[ 3.3 ] Elasticity of Demand Key Terms elasticity of demand inelastic elastic unitary elastic total revenue

Elasticity Defined Are there some products that you would continue to buy, even if the price were to rise dramatically? Are there other goods that you would cut back on, or stop buying altogether, if there were just a slight increase in price? How much is too much? No matter how you answer these questions, economists have a way to describe your behavior.

Elasticity Defined The Concept of Elasticity How Elasticity Is Calculated Price Range Elasticity Values

What Is Elasticity of Demand? Elasticity of demand is a measure of how consumers react to a change in price. Demand for a good that consumers will continue to buy despite a price increase is inelastic. Demand for a good that is very sensitive to changes in price is elastic.

Elasticity Defined Gasoline is a good many people continue to buy even when the price rises. Analyze Political Cartoons What does this cartoon suggest about the challenge consumers face when gas prices rise?

Elasticity Defined Economists use the steps shown here to calculate elasticity of demand. Generate Explanations Why do you think observers may want to be able to measure elasticity precisely?

Factors Affecting Elasticity Why is the demand for some goods so much less elastic than for other goods? Rephrase the question and ask yourself, “What is essential to me? What goods must I have, even if the price rises greatly?” The goods you list might have some traits that set them apart from other goods and make your demand for those goods less elastic. Several different factors, including several non-price determinants, can affect a person’s elasticity of demand for a specific good.

Factors Affecting Elasticity Availability of Substitutes Relative Importance Necessities Versus Luxuries Change Over Time

Calculating Elasticity Elasticity of Demand Elasticity is determined using the following formula: Elasticity = Percentage change in quantity demanded Percentage change in price To find the percentage change in quantity demanded or price, use the following formula: subtract the new number from the original number, and divide the result by the original number. Ignore any negative signs, and multiply by 100 to convert this number to a percentage: Percentage change = Original number – New number Original number x 100

Factors Affecting Elasticity Elasticity of demand varies from situation to situation. Analyze Charts Why do you think demand is inelastic for the two items on the left side of the continuum?

Factors Affecting Elasticity For a football fan, there is no substitute for tickets to your favorite team’s game. Draw Conclusions Would you expect a Dallas Cowboys fan to pay more or less to watch two other teams?

Factors Affecting Elasticity When home prices fell when recession hit in 2007, demand did not rise immediately. Generate Explanations Why might demand for housing stay flat at first even when prices fall sharply?

How Elasticity Affects Revenue Elasticity is important to the study of economics because elasticity helps us measure how consumers respond to price changes for different products. Elasticity is also an important tool for business planners, like the pizzeria owner described earlier in this topic. The elasticity of demand determines how a change in prices will affect a firm’s total revenue, or income.

How Elasticity Affects Revenue Total Revenue Total Revenue and Elastic Demand Total Revenue and Inelastic Demand How Elasticity Affects Pricing Policies

Inelastic Demand Inelastic Demand Price Quantity $7 $6 $5 $4 $3 $2 $1 Inelastic Demand 5 10 15 20 25 30 Demand If demand is inelastic, consumers are not very responsive to changes in price. A decrease in price will lead to only a small change in quantity demanded, or perhaps no change at all. Follow this demand curve from left to right as the price decreases sharply from $6 to $2. The price decreases from $6 to $2, a decrease of about 67 percent. $6 – $2 $6 x 100 = 67 The quantity demanded increases from 10 to 15, an increase of 50 percent. 10 – 15 10 x 100 = 50 Elasticity of demand is about 0.75. The elasticity is less than 1, so demand for this good is inelastic. The increase in quantity demanded is small compared to the decrease in price. 50% 67% = 0.75

Elasticity and Revenue The elasticity of demand determines how a change in prices will affect a firm’s total revenue or income. A company’s total revenue is the total amount of money the company receives from selling its goods or services. Firms need to be aware of the elasticity of demand for the good or service they are providing. If a good has an elastic demand, raising prices may actually decrease the firm’s total revenue.

How Elasticity Affects Revenue This art gallery needs to sell only a small number of its high-priced artworks to generate significant total revenue.

How Elasticity Affects Revenue Achieving higher revenue means finding the best combination of price and quantity demanded. Analyze Charts Why does revenue for this restaurant fall when price increases from $4 to $5?

How Elasticity Affects Revenue The relationship between price change and revenue differs depending on elasticity of demand. Analyze Charts In which two situations will revenue likely fall in response to a price change?

Quiz: Elasticity Defined Describe your demand for a product if you buy the same amount of it or just a small amount less after a large price increase. A. elastic B. unitary elastic C. inelastic D. hyperelastic

Quiz: Factors Affecting Elasticity Which of the following is an example of inelastic demand? A. Jason wants the most expensive cellphone. He decides to get a cheaper model. B. Priya wants to go to the season-opening game. Tickets to another game cost less, but she still buys tickets for the opener. C. Tianna wants to try out a new, expensive restaurant. She goes to another restaurant whose food is excellent and costs less. D. Shawn wants to buy a house in one neighborhood. But after searching, he decides to buy a house elsewhere instead.

Quiz: How Elasticity Affects Revenue How does elasticity affect potential revenue for a firm? A. If demand for a good is inelastic, lowering the price could raise revenue. B. If demand for a good is inelastic, raising the price could reduce revenue. C. If demand for a good is elastic, raising the price must increase revenue. D. If demand for a good is elastic, raising the price could reduce revenue.