Introduction to Economics: Social Issues and Economic Thinking Wendy A. Stock PowerPoint Prepared by Z. Pan CHAPTER 5 ELASTICITY Copyright © 2013 John Wiley & Sons, Inc. / Photo Credit: ©Katja Bone/iStockphoto

 Define elasticity  Classify elasticity values into inelastic and elastic categories  Use the elasticity coefficient to assess the price elasticity of demand  Assess the relationship between elasticity and total revenue  Describe the factors that determine the price elasticity of demand Copyright © 2013 John Wiley & Sons, Inc. 2 AFTER STUDYING THIS CHAPTER, YOU SHOULD BE ABLE TO:

 Elasticity is a measure of responsiveness between any two variables.  The Price Elasticity of Demand measures the responsiveness of quantity demanded to changes in price, all expressed in percentage terms. Copyright © 2013 John Wiley & Sons, Inc. 3 WHAT IS ELASTICITY?

 Elastic Demand: When a given percent change in the price of a good causes a larger percent change in the quantity demanded of the good.  Inelastic Demand: When a given percent change in the price of a good causes a smaller percent change in the quantity demanded of the good.  Unit Elastic Demand: When a given percent change in the price of a good causes an equal size percent change in the quantity demanded. Copyright © 2013 John Wiley & Sons, Inc. 4 CATEGORIES OF ELASTICITY

Perfectly Inelastic Demand: Quantity demanded does not change in response to a price change. Copyright © 2013 John Wiley & Sons, Inc. 5 CATEGORIES OF ELASTICITY

Perfectly Elastic Demand: Quantity demanded changes by an infinite amount in response to a price change. Copyright © 2013 John Wiley & Sons, Inc. 6 CATEGORIES OF ELASTICITY

Copyright © 2013 John Wiley & Sons, Inc. 7 THE ELASTICITY COEFFICIENT

Copyright © 2013 John Wiley & Sons, Inc. 8 SUMMARY OF ELASTICITY COEFFICIENT VALUES

 Total Revenue (TR) is the amount of money earned when a supplier sells a given quantity of a good. TR = $50/shirt x 20 shirts/day = $100/day TR = P * Q Copyright © 2013 John Wiley & Sons, Inc. 9 ELASTICITY AND TOTAL REVENUE If P, but Q TR ? Depending on Ed

Copyright © 2013 John Wiley & Sons, Inc. 10 ELASTICITY AND TOTAL REVENUE If demand is elastic, the percentage change in quantity demanded is greater than the percentage change in price. Elastic; E d >1; (E d = %ΔQ / %ΔP) %ΔQ >%ΔP; P ↑ → TR ↓ P ↓ → TR ↑

Copyright © 2013 John Wiley & Sons, Inc. 11 ELASTICITY AND TOTAL REVENUE If demand is inelastic, the percentage change in quantity demanded is less than the percentage change in price. Inelastic; E d < 1; (E d = %ΔQ / %ΔP) %ΔQ < %ΔP; P ↓ → TR ↓ P ↑ → TR ↑

Copyright © 2013 John Wiley & Sons, Inc. 12 ELASTICITY AND TOTAL REVENUE

 The Availability of Substitutes  Luxury versus Necessity Goods  The Length of Time Available to Adjust to a Price Change  The Portion of Income Spent on the Good Copyright © 2013 John Wiley & Sons, Inc. 13 DETERMINANTS OF THE PRICE ELASTICITY OF DEMAND

 The Availability of Substitutes The more substitutes available, the more elastic is the demand for a good. Copyright © 2013 John Wiley & Sons, Inc. 14 DETERMINANTS OF THE PRICE ELASTICITY OF DEMAND

 Luxury versus Necessity Goods Demand for luxuries is more elastic than demand for necessity goods. Copyright © 2013 John Wiley & Sons, Inc. 15 DETERMINANTS OF THE PRICE ELASTICITY OF DEMAND

 The Length of Time Available to Adjust to a Price Change The longer the time passes since the price change, the easier to make adjustment to price change, thus the more elastic is demand. Copyright © 2013 John Wiley & Sons, Inc. 16 DETERMINANTS OF THE PRICE ELASTICITY OF DEMAND

 The Portion of Income Spent on the Good The price elasticity of demand tends to be larger for goods that make up a larger portion of people’s incomes. Copyright © 2013 John Wiley & Sons, Inc. 17 DETERMINANTS OF THE PRICE ELASTICITY OF DEMAND

QUESTIONS/DISCUSSIONS Copyright © 2013 John Wiley & Sons, Inc If the demand for milk is inelastic, will a small reduction in the supply of milk result in an increase or a decrease in the total revenue earned by milk suppliers? Why?

Copyright © 2013 John Wiley & Sons, Inc. 19 KEY CONCEPTS Elasticity Price Elasticity of Demand Elastic demand Inelastic demand Perfectly inelastic demand Perfectly elastic demand Unit elastic of demand Elasticity coefficient Total revenue