1 Price Elasticity of Demand  In order to predict what will happen to total expenditures,  We must know how much quantity will change when the price.

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Presentation transcript:

1 Price Elasticity of Demand  In order to predict what will happen to total expenditures,  We must know how much quantity will change when the price changes  Price elasticity of demand is  the percentage change in the quantity demanded that results from a one-percent change in its price

2 Price Elasticity of Demand

3 Price Elasticity  Elastic – quantity changes by a lot when price changes even a little  price elasticity is greater than one  Inelastic – quantity changes by a little when price changes even a lot  price elasticity is less than one  Unit elastic – quantity change = price change  price elasticity equals one  When calculating price elasticity of demand, you will always get a negative- WHY?  For convenience we will take the absolute value

4 Price Elasticity and Expenditures  For an elastic product  Quantity demanded is highly responsive  Percentage change in quantity dominates  An increase in price will reduce total expenditure  A decrease in price will increase total expenditure  For an inelastic product  Quantity demanded is not responsive  Percentage change in price dominates  An increase in price will increase total expenditure  A decrease in price will decrease total expenditure

5 Fig Graphical Interpretation of Price Elasticity of Demand

6 Other Elasticities of Demand  Income Elasticity of Demand  The amount by which the quantity demanded changes in response to a one- percent change in income  Positive for normal goods  Negative for inferior goods

7 Other Elasticities of Demand  Cross Price Elasticity of Demand  The amount by which the quantity demanded of one good changes in response to a one-percent change in the price of another good  Positive for substitutes  Negative for complements

8 Perfect Elasticity  Perfectly Elastic demand  Price elasticity of demand is infinite  Even the slightest change in price leads consumers to find substitutes  Perfectly Inelastic demand  Price elasticity of demand is zero  Consumers do not switch to substitutes even when price increases dramatically  Do goods like these exist?

9 Fig Perfectly Elastic and Perfectly Inelastic Demand Curves