Chapter 5: Demand and Supply Elasticity. Elasticity of Demand  Also called Price Elasticity of Demand  Measures consumer responsiveness to change in.

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Presentation transcript:

Chapter 5: Demand and Supply Elasticity

Elasticity of Demand  Also called Price Elasticity of Demand  Measures consumer responsiveness to change in price  Example: If the Price of Pepsi goes up $0.50, will you continue to purchase Pepsi?  Example: If you the price of insulin decreases 50%, will you buy more insulin?

Types of Elasticity  Based on this equation:  Demand is elastic if coefficient is greater than one  Demand is unit elastic if coefficient is exactly one  Demand is inelastic if coefficient is less than one

Elasticity can also be measured using the Total Revenue Test  Total Revenue is Price X Quantity Sold  (This is NOT the same thing as Profit)  If total revenue increases as prices lower then demand is elastic  If total revenue decreases when prices lower then demand is inelastic

Total Revenue Test PriceQuantityTotal Revenue Marginal Revenue (Extra Revenue) Elastic, Inelastic, or Unit elastic $141 $122 $103 $84 $65 $46 $27

Total Revenue Test PriceQuantityTotal Revenue Marginal Revenue (Extra Revenue) Elastic, Inelastic, or Unit elastic $141 $122$24 $103$30 $84$32 $65$30 $46$24 $27$14

Total Revenue Test PriceQuantityTotal Revenue Marginal Revenue (Extra Revenue) Elastic, Inelastic, or Unit elastic $141 $122$24$10 3$30$6 $84$32$2 $65$30-$2 $46$24-$6 $27$14-$10

Total Revenue Test PriceQuantityTotal Revenue Marginal Revenue (Extra Revenue) Elastic, Inelastic, or Unit elastic $141 $122$24$10Elastic $103$30$6Elastic $84$32$2Elastic $65$30-$2Inelastic $46$24-$6Inelastic $27$14-$10Inelastic

What influences elasticity of demand?  Availability of Substitutes  Many substitutes – Elastic  Few substitutes - Inelastic  Price Relative to Income  Expensive item - Elastic  Inexpensive item - Inelastic  Necessities versus Luxuries  Necessity – Inelastic  Luxury - Elastic  Time Needed to Adjust to a Price Change  Short time after change – elastic  Long time after price change - inelastic

Elasticity of Supply  Availability of inputs  Supply Change  Mobility of inputs  Storage capacity  Time to adjust to a price change  See page 93 for examples

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