4-3: W HAT IS E LASTICITY OF D EMAND ?

W HAT IS ELASTICITY OF DEMAND ? Elasticity of demand: a measure of how responsive consumers are to price change Demand can be described as elastic or inelastic

E LASTIC D EMAND Demand is elastic when a change in price, either up or down, leads to a relatively larger change in the quantity demanded Elastic goods are price sensitive

E LASTIC D EMAND C URVE Draw your elastic demand curve here: Elastic demand curves have gradual slopes; they are more horizontal than vertical because of the greater change in quantity demanded

I NELASTIC D EMAND Demand is inelastic when a change in price leads to a relatively smaller change in the quantity demanded Insulin for diabetics

I NELASTIC D EMAND C URVE Draw your inelastic demand curve here: Inelastic demand curves have steep slopes; they are more vertical than horizontal because quantity demanded changes very little

T HE R UBBER B AND E XAMPLE If a rubber band represents quantity demanded: When the quantity demanded increases the demand is elastic and the rubber band stretches When the quantity demanded barely changes demand is inelastic and the rubber band stretches very little

E LASTICITY OF D EMAND FOR G OODS AND S ERVICES Example of elastic demand: a brand of laptops goes on sale The price of the laptops is decreased by 20% As a result, quantity demanded increases by 30%

E LASTICITY OF D EMAND FOR G OODS AND S ERVICES ( CONTINUED 1) The percentage change in quantity demanded is greater than the percentage change in price This means demand is elastic

E LASTICITY OF D EMAND FOR G OODS AND S ERVICES ( CONTINUED 2) Example of inelastic demand: diabetics require daily insulin injections to regulate their blood sugar If the price of insulin were to rise sharply, diabetics would still need the same amount of insulin

E LASTICITY OF D EMAND FOR G OODS AND S ERVICES ( CONTINUED 3) If the price of insulin were to decrease, diabetics would not require any additional insulin This means demand for insulin is inelastic because the quantity demanded remains relatively constant

U NIT E LASTIC D EMAND Unit elastic demand: when the percentage change in price and quantity demanded are the same No good or service is ever really unit elastic

W HAT D ETERMINES E LASTICITY ? 1. Substitute Goods or Services: If there is no substitute for a good or service demand tends to be inelastic If many substitutes are available, demand tends to be elastic

W HAT D ETERMINES E LASTICITY ? 2. Proportion of Income: the percentage of your income that you spend on a good or service is another factor that affects elasticity If you spend 10% of your income on a hobby and the price of that hobby rises your demand will fall and be elastic Demand for products that cost little of your income tend to be inelastic (think of buying pens or pencils)

W HAT D ETERMINES E LASTICITY ? 3. Necessities versus Luxuries: a necessity is something you must have; a luxury is something that you desire to have

W HAT D ETERMINES E LASTICITY ? Demand for necessities tends to be inelasticeven if the price rises, consumers will pay whatever they can afford for necessary goods and services If the price of milk rises too much, consumers may choose to purchase a substitute, cheaper brand, of milk

W HAT D ETERMINES E LASTICITY ? Demand for luxuries tends to be elastic Consumers do not need plasma TVs and will think twice about paying a higher price for a good they do not truly need

T OTAL R EVENUE Total revenue: a companys income from selling its products Total Revenue=P x Q Where P=price and Q=quantity

T OTAL R EVENUE T EST Definition: a method of measuring elasticity by comparing total revenues Elasticity can be measured by comparing total revenue a business would receive when offering its product at various prices

E XAMPLE : T OTAL R EVENUE Fill-in the total revenue figures : $ of a Movie Ticket Quantity Demanded per Month Total Revenue ($) 121,000 12, ,000 20,000 86,000 48, ,000 72, ,000 80,000

Q UESTIONS 1. In early 2004 news articles reported that prescription drug prices were rising almost 3 times faster than the prices of other goods. Identify the factors that explain why the drug companies were able to raise prices so sharply.