Explorations in Economics Alan B. Krueger & David A. Anderson

WHAT IS ELASTICITY? Elasticity of demand is a measure of how strongly consumers respond to a change in the price of a good, calculated as the percentage change in the quantity demanded divided by the percentage change in price. Demand is elastic if consumers respond to a change in PRICE with a relatively large change in the quantity demanded Demand is inelastic if consumers respond to a change in PRICE with a relatively small change in the quantity demanded. Demand is unit-elastic if consumers respond to a change in price by changing the quantity demanded by the same percentage. Point out that elasticity is a measure of responsiveness. Examples: when gas prices go up we still buy gas but we may carpool or use mass transit—inelastic demand. Think about other goods or service that response in different way to changes in price.

WHAT MAKES DEMAND MORE OR LESS ELASTIC? Necessities versus luxuries: If you need it, your demand is relatively inelastic. The availability of close substitutes: No substitutes means your demand is inelastic. The share of income spent on the good: If It is a large expense, your demand is elastic. Time: If you can wait, your demand is elastic. Drill students with these questions: If you have more income, does your elasticity increase or decrease for luxuries? If you need a medication to live, is the elasticity of the medication for you elastic or inelastic? What about someone who does not need the medication at all.? If the price of tickets at Yankee Stadium increases by $5 per ticket, will everybody stop going to cheer the team? Are there substitutes available for the tickets to the Yankee game? Think about GDP during recessions. Consumer spending decreases quickly for durable goods because they are more expensive and you can usually put off the purchase. They represent a large portion of your income and budget.

Perfectly Elastic Demand When demand is perfectly elastic, the demand curve is horizontal. At the price listed here consumers will buy an infinite amount.

Perfectly Inelastic Demand When demand is perfectly inelastic, the demand curve is vertical. At the quantity shown here a consumer will buy the product no matter what the price…Insulin, a medication for diabetics, is an example.

PREDICTING ELASTICITY Ask students to explain the examples and the elasticity characteristic. Ask the students to provide more examples and explain.

COMPARING ELASTICITIES By calculating the value of elasticity, economists can categorize the demand for goods according to how sensitive consumers are to price changes. We can specify whether demand is elastic, inelastic, or unit elastic, depending on the value of elasticity. Depending on the course you are teaching you may need to spend some time teaching HOW to calculate elasticity. Remember that the elasticity of demand is equal to the percentage change in the quantity demanded divided by the percent-age change in the price. Refer to Show Me The Numbers p. 131-132 in the text. The total revenue test is easier for students to comprehend and apply. The larger the elasticity, the greater the percentage change in quantity demanded relative to the percentage change in price and the stronger the response to a price change.

COMPARING ELASTICITIES

SPENDING, REVENUE, AND ELASTICITY Point out how large the price change in (a) has a LARGER response in terms of quantity than in (b). In (c) the change is the same percentage so it is called unit elastic.

ELASTICITY, TOTAL SPENDING, & TOTAL REVENUE Total revenue is all the money consumers spend on a good, and firms receive for a good, during a particular period of time: it is the price of the good multiplied by the quantity of the good sold. Changes in Total Revenue with Elastic Demand Price increases = total revenue decreases Price decreases = total revenue increases Depending on the curriculum you may have to spend a class period or two on this. Use a demand schedule and multiply P x Q. Point out elastic demand means price and total revenue move in the OPPOSITE direction.

ELASTICITY, TOTAL SPENDING, & TOTAL REVENUE Total revenue is all the money consumers spend on a good, and firms receive for a good, during a particular period of time: it is the price of the good multiplied by the quantity of the good sold. Changes in Total Revenue with Inelastic Demand Price increases = total revenue increases Price decreases = total revenue decreases Point out inelastic demand means price and total revenue more in the SAME direction.

ELASTICITY, TOTAL SPENDING, & TOTAL REVENUE Total revenue is all the money consumers spend on a good, and firms receive for a good, during a particular period of time: it is the price of the good multiplied by the quantity of the good sold. Constant Total Revenue with Unit-Elastic Demand Price increases or decreases = total revenue unchanged. Unit elasticity means that price changes and total revenue does not change.

ELASTICITY, TOTAL SPENDING, & TOTAL REVENUE Changes in Total Revenue with Elastic Demand Changes in Total Revenue with Inelastic Demand Constant Total Revenue with Unit- Elastic Demand Quiz students using Table 12.3. What happens to total revenue when demand is elastic What happens to total revenue when demand is elastic and the price decreased? What happens to total revenue when demand is inelastic and the price increased? What happens to total revenue when demand is inelastic and the price decreased? What happens to total revenue when demand is unit elastic and the price increased? What happens to total revenue when demand is unit elastic and the price decreased?

Module 12 Review What is… A. Elasticity of demand? B. Elastic demand? C. Inelastic demand? D. Necessity? E. Unit- elastic demand? F. Total revenue? G. Luxury? H. Close substitute? Have students add the notes to their vocabulary notebook.