Chapter 4 : Lesson 3 Elasticity of Demand

Essential Question: What factors determine a product’s demand elasticity?

Elasticity of Demand : is a measure of how consumers respond to price changes Measures how drastically buyers will cut back or increase their demand for a good when the price rises or falls

Inelastic: If you buy the same amount or just a little bit less of a good after a large price increase, your demand is Inelastic (price changes don’t matter)

Elastic: If you buy much less of a good after a small price increase, your demand is Elastic (very responsive to price changes)

4. Factors that Affect Elasticity

1. Availability of Substitutes - If there are few substitutes for a good, then even when its price rises greatly, you might still buy it – you believe there are no good alternatives: your demand is inelastic

2. Relative Importance - How much of your budget do you spend on the good? The higher the jump in price, the more you will have to adjust your purchases

3. Necessities v. Luxuries - a necessity is a good people will always buy, even when the price increases (demand is inelastic) ex: milk - a luxury can easily be given up (demand is elastic) ex: steak

4. Change over Time - Consumers often need time to change their spending habits, because it takes time to find substitutes ex: gas

Total Revenue: is the amount of money the company receives by selling its goods Determined by 2 factors: Price of goods Quantity of goods sold

Total Revenue & Elastic Demand When a good has an elastic demand, raising the price of each good sold by 20% can decrease the quantity sold by enough to reduce the firm’s total revenue (setting prices too high/low can hurt $$) Price of a Slice of Pizza Quantity Demanded (per day) Total Revenue $1.00 300 $300.00 $2.00 250 $500.00 $3.00 200 $600.00 $4.00 150 $5.00 100 $6.00 50

Elasticity and Revenue ELASTIC DEMAND As the price is raised… Total revenue rises As the price is lowered… Total revenue falls INELASTIC DEMAND As the price is lowered Total revenue falls As the price is raised.. Total revenue rises

Effect of a Price Change on Quantity Demanded Sum it up Effect of a Price Change on Quantity Demanded INELASTIC DEMAND ELASTIC DEMAND Not sensitive to price change Substitutes not available Less of income spent on good Seen as necessity No time to react in the short term Very sensitive to price change Substitutes available More of income spent on good Seen as luxury Substitutes can be found in the long term

Factors that affect elasticity Does the product have substitutes Y= Elastic N=Inelastic Importance - % of your budget - expensive vs. inexpensive expensive- elastic cheap-inelastic Necessity vs Luxury (needs vs wants) need-inelastic want-elastic

Which item is more Elastic? 6 pack of cola or a ten speed bicycle A school t-shirt or a school yearbook Medical services for a badly cut hand or medical services for a runny nose Cheeseburger or air conditioning in Arizona in the summer Air conditioning in AZ this summer or Air conditioning in AZ over the next few summers

Answers Reason 10 speed bicycle Expensive Many Subs School t-shirt Runny nose Cheeseburger A/C next few summers Expensive Many Subs Many subs/not a need Many subs Time to plan/subs

Review Question: Chapter 4 : Lesson 3 Read pages 114-119 and answer Review Questions on page 119. Hand in Google Class Room.