How sensitive is demand to price changes? Elasticity of Demand How sensitive is demand to price changes?

Which demand curve is most sensitive to price changes? Slope of Demand Curves Demand curves do not all have the same slope Slope indicates response of buyers to a change in price Price ↑ 10% => Qty Demanded ↓ ? (how much?) D1 Price Qty D1 D1 Which demand curve is most sensitive to price changes?

ELASTICITY OF DEMAND Elasticity of demand (Ed) measures the sensitivity of quantity demanded in response to a change in price: Ed = % change Qty D % change Price

Elastic Demand Curves Elastic Demand Demand is sensitive to price changes Demand Curves are flat Ed > 1 A % ↑ Price leads to a greater % decline in Qty Demanded D1 Px Qty Ed = % change Qty D % change Price

Example: Elastic Demand Curve . 10% rise in Price causes a Greater than 10 % decline in Qty D Ed = % change Qty D % change Price Ed = 1.5

Inelastic Demand Curves Demand NOT sensitive to price changes Curves are STEEP Ed < 1 A % ↑ Price leads to a SMALLER % decline in Qty Demanded D1 Px Qty Ed = % change Qty D % change Price

Example: Inelastic Demand Curve ↑% Price changes Leads to a smaller % decline in Qty D +100% Ed = 0.1 Quantity Ed = % change Qty D % change Price -10%

Elasticity depends on: Number of close substitutes more substitutes => more elastic demand Whether the good is considered a necessity Necessities tend to be inelastic, luxury goods are elastic Proportion of income spent larger proportion of income more elastic Time period Longer the time period => the more elastic demand is

Price Elastic or Price Inelastic? Gasoline Soda Price Inelastic No real substitutes Price Elastic Many substitutes Heart Surgery Table Salt Price Inelastic Necessity & No real substitutes, Short time period Price Inelastic Small proportion of income, no good substitute

Total Revenue & Profit Total Revenue = Price X Quantity Profit = Total Revenue - Expenses Elasticity determines the effect on total revenue Total Revenue => when Prices elastic goods Total Revenue => when Prices inelastic goods

Elastic Demand Raising prices will lower total revenue! $200 $150 200 300 $200 $150 Raising prices will lower total revenue!

Elasticity Worksheet Elastic Demand Inelastic Demand Total Revenue = Px Qty D1 Px Qty Total Revenue = Price * Quantity

GDP