Interpreting Price Elasticity of Demand By looking at the elasticity of goods we can have a deeper understanding of why people make the choices they do. It also lets us take a deeper look at supply and demand

What Price Elasticity of Demand Tells Us Panel (a) shows a perfectly inelastic demand curve (a vertical line). At $5, consumers will buy any quantity of pink tennis balls, but they will buy none at a price above $5. As a result, the price elasticity of demand is infinite for pink tennis balls. The quantity of heart bypass surgeries demanded is always 1 million, regardless of price. As a result, the price elasticity of demand is zero—quantity demanded is unaffected by price. Panel (b) shows a perfectly elastic demand curve, which is a horizontal line.

How Elastic Is Elastic? Demand is perfectly inelastic when quantity demanded does not respond at all to change in price. A perfectly inelastic demand curve is a vertical line. Demand is perfectly elastic when any price increase causes quantity demanded to drop to zero. A perfectly elastic demand curve is a horizontal line.

How Elastic Is Elastic? Elastic: price elasticity of demand > 1 Inelastic: price elasticity of demand < 1 Unit-elastic: price elasticity of demand = 1 In 2018, San Francisco voters contemplated a $3 increase on the Bay Bridge toll. An issue was the price elasticity of demand, which would determine the resulting drop in use.

Unit-Elastic, Inelastic, and Elastic Demand Panel (b) shows inelastic demand: a 20% price increase yields a 10% fall in quantity demanded (price elasticity of demand = 0.5.). Panel (a) shows unit-elastic demand: a 20% price increase yields a 20% fall in quantity demanded (price elasticity of demand = 1). Panel (c) shows elastic demand: a 20% price increase yields a 40% drop in quantity demanded (price elasticity of demand = 2).

Elasticity and Total Revenue Total revenue is the total value of sales of a good or service. It equals the price multiplied by quantity sold. The green rectangle in panel (a) is total revenue generated from 1,100 drivers who each pay a toll of $0.90. The net effect (whether revenue increases or decreases) depends on the price elasticity of demand. Due to the quantity effect, total revenue falls by area A. Panel (b) shows how total revenue changes when price rises from $0.90 to $1.10. Due to the price effect, total revenue increases by area C.

Elasticity and Total Revenue For inelastic demand, a price rise increases total revenue. The price effect is stronger than the quantity effect. For elastic demand, a price rise reduces total revenue. The quantity effect is stronger than the price effect. For unit-elastic demand, a price rise does not change total revenue. The quantity effect and the price effect exactly offset each other.

Price Elasticity Along the Demand Curve The upper panel shows a demand curve matching the demand schedule. You can see that at a low price, raising the price increases total revenue. So demand is inelastic at low prices. At a high price, however, a rise in price reduces the total revenue. So demand becomes more elastic at higher prices. The lower panel shows how total revenue changes along that demand curve: at each price and quantity combination, the height of the bar is total revenue.

Determinants of Price Elasticity of Demand 1) Close Substitutes: Price elasticity of demand increassubstituteses if there are close (pizza) and decreases if there are no close substitutes (bypass surgery). 2) Share of Income: Price elasticity of demand falls if spending is a small share of income (eggs) and rises if it’s is a large share of income (houses). 4) Time: Price elasticity of demand increases as consumers have more time to adjust to price change, so long-run elasticity is usually higher than short-run elasticity. 3) Necessity vs. Luxury: Price elasticity of demand is low for necessities (EpiPens) and high for luxuries (Teslas).

Determinants of Price Elasticity of Demand You may want a Tesla, but you probably don’t need one, so your price elasticity of demand for a Tesla is probably high.

Summary and Review 1) What are the three types of price elasticity of demand? Inelastic, elastic, and unit-elastic. 2) If demand were perfectly inelastic, what shape would the demand curve be? Vertical. 3) If demand were perfectly elastic, what shape would the demand curve be? Horizontal.

Summary and Review 4) If a good or service has unit-elastic price elasticity of demand, by what percentage would a 10% change in price reduce quantity demanded? 10%. 5) If elasticity is >1, demand is said to be _____. elastic 6) If elasticity is <1, demand is said to be _____. inelastic 7) If elasticity = 1, demand is said to be _____. unit elastic

Summary and Review 8) If total revenue increases after a price increase, what is the elasticity of demand? Inelastic. 9) If total revenue decreases after a price increase, what is the elasticity of demand? Elastic. 10) If total revenue is the same after a price increase, what is the elasticity of demand? Unit-elastic.

Walkthrough: Free-Response Question 1 1. Draw a correctly labeled graph of a perfectly inelastic demand curve. a. What is the price elasticity of demand for this good? b. What is the slope of the demand curve for this good? c. Is this good more likely to be a luxury or a necessity? Explain. (5 points) 1 point: A graph with “Price” (or “P”) on the vertical axis, “Quantity” (or “Q”) on the horizontal axis, and a vertical line labeled “Demand” (or “D”) 1 point: Necessity 1 point: Since you have to have a necessity (such as a life-saving medicine), you do not change the quantity you purchase when the price changes. 1 point: Zero 1 point: Infinite or undefined