Price Elasticity. HOW MUCH MORE OR LESS? DOES IT MATTER? THE LAW OF DEMAND SAYS... Consumers will buy more when prices go down and less when prices go.

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Presentation transcript:

Price Elasticity

HOW MUCH MORE OR LESS? DOES IT MATTER? THE LAW OF DEMAND SAYS... Consumers will buy more when prices go down and less when prices go up 2

Elasticity Elasticity shows how sensitive quantity is to a change in price.

Elasticity of Demand Elasticity of Demand- Measurement of consumers responsiveness to a change in price. What will happen if price increase? How much will it effect Quantity Demanded Who cares? Used by firms to help determine prices and sales Used by the government to decide how to tax

Inelastic Demand

If price increases, quantity demanded will fall a little If price decreases, quantity demanded increases a little. In other words, people will continue to buy it. 20% 5% INelastic = Quantity is INsensitive to a change in price. Examples: Gasoline Milk Diapers A INELASTIC demand curve is steep! (looks like an “I”) Chewing Gum Medical Care Toilet paper

Inelastic Demand 20% 5% General Characteristics of INelastic Goods: Few Substitutes Necessities Small portion of income Required now, rather than later Elasticity coefficient less than 1

Elastic Demand

If price increases, quantity demanded will fall a lot If price decreases, quantity demanded increases a lot. In other words, the amount people buy is sensitive to price. Elastic = Quantity is sensitive to a change in price. An ELASTIC demand curve is flat! Examples: Soda Boats Beef Real Estate Pizza Gold

Elastic Demand General Characteristics of Elastic Goods: Many Substitutes Luxuries Large portion of income Plenty of time to decide Elasticity coefficient greater than 1

Elastic or Inelastic? Beef- Gasoline- Real Estate- Medical Care- Electricity- Gold- Elastic INelastic -.20 Elastic INelastic -.31 INelastic -.13 Elastic What about the demand for insulin for diabetics? Perfectly INELASTIC (Coefficient = 0) What if % change in quantity demanded equals % change in price? Unit Elastic (Coefficient =1) 45 Degrees

Total Revenue Test Uses elasticity to show how changes in price will affect total revenue (TR). (TR = Price x Quantity) Elastic Demand- Price increase causes TR to decrease Price decrease causes TR to increase Inelastic Demand- Price increase causes TR to increase Price decrease causes TR to decrease Unit Elastic- Price changes and TR remains unchanged Ex: If demand for milk is INelastic, what will happen to expenditures on milk if price increases?

Is the range between A and B, elastic, inelastic, or unit elastic? A B 10 x 100 =$1000 Total Revenue 5 x 225 =$1125 Total Revenue Price decreased and TR increased, so… Demand is ELASTIC 125% 50%