1. Elasticity of Demand
4.3

2. Cause and Effect
Page 103 – Netflix CEO Reed Hastings credited the market’s demand elasticity for the company’s success.
Elasticity – is a general measure of responsiveness 0R an important cause-and-effect relationship in economics
A measure of responsiveness that shows how one variable responds to change in another variable.

3. Dependent vs. Independent Variable
Elasticity tells us how a dependent variable – such as quantity demanded, responds to a change in an independent variable – such as price.

4. Explaining Independent Vs. Independent Variables
If you have 20 iPods ordered by a group of people, that number is pretty concrete. We *know* that only 20 iPods were ordered.
Conversely, the price is an independent variable. It’s set by the supplier, and can be arbitrary – meaning anything the supplier wishes to order.
Other measures, such as income or supply can also be understood in terms of elasticity.

5. Demand Elasticity Consumers react to a change in price How?
By changing the quantity demanded
Although the size of their reaction varies
Their response is known as demand elasticity (see later slides)
OR the extent to which a change in price causes a change in the quantity demanded.

6. Elastic Demand Vs Inelastic Demand

7. Elastic Demand
Economists say that the demand is elastic when a given change in price causes a relatively larger change in quantity demanded. A B

8. Because the percentage change in quantity demanded is relatively larger than the percentage change in price, demand between those two points is elastic. (See Figure 4.5 page 104).

9. Availability of Good Quality Substitutes
Easily substitutable goods will enable buyers to switch to an alternative good and thus such goods will exhibit greater elasticity than goods that do not have substitutes available
Comparability of the available substitute(s) in terms of quality to the original good is an important sub-variable
The better the substitute(s) can replace the original good in terms of desirability, affordability, practicality etc. the more elastic the good will become

10. Examples If the graph looks like this – 10% increase in bus fair
What does this say about substitutes?
What might they be?
However, this may mean more inconvenience and/or longer journey time for example and thus will form part of his consideration before switching that mode of transport and it may take a certain price difference before he will resort to this option representing the substitute's quality

11. Inelastic Demand For other products, demand may be inelastic
Which means that a given change in price causes relatively smaller change in the quantity demanded. OR
A type of elasticity where change in price causes a relatively smaller change in the quantity demanded.

12. What products can you think of where the graph looks like this?

13. A contrasting inelastic good would be water which is arguably non-substitutable so a local community faced with rising water costs will be left with little choice but to pay the increased costs forming a price inelastic good.

14. Goods and services for which no substitutes exist are generally inelastic.
Addictive drugs, whether psychologically addictive or physically
Goods where dependency plays a key role will naturally exhibit inelastic properties. At aggregate level, rising costs of such goods are unlikely to reduce demand significantly. Classic examples of such goods would be gasoline, alcohol and tobacco or in an extreme case, heroin.
A heroin addict will virtually go to any length to achieve the next fix irrespective of cost.

15. Why do governments tend to tax items like gas, cigarettes and alcohol more heavily than things like vegetables or red meat?
Governments often place taxes on these types of goods, namely alcohol, tobacco and fuel because of their highly inelastic demand since consequently such goods are assured revenue generators for the treasury.

16. How do you determine Elasticity of Demand?
Demand Elasticity – also known as PED – price elasticity of demand is determined by a number of factors that essentially all fall under the umbrella of "choice".

17. 1. Choice
By choice we mean the power of choice that the consumer of a given good holds to give up the consumption of said good.
How easy is it to give that item up and not buy it at all, or buy a substitute?
The greater this choice the more price elastic the good will be and, by contrast, as the balance of this power falls in favor of the supplier the more inelastic the good will be.

18. Examples
For example; there are many choices of margarine. Consumers can easily give up one brand for another. There are fewer choices for cable television. What does this mean in terms of the pricing for cable television?
This is due to the consumer's "Perceived Value". A good which is difficult to replace or give up consuming will have a higher perceived value than that which is more easily replaced thus the consumer will be willing to pay more for such a good.

19. 2. Perceived Value
Represents the absolute maximum price a consumer is willing to pay for a good. When the price exceeds this level, the consumer will give up consumption of this good.
Why aren’t more people dropping Verizon and AT&T and switching to T-Mobile and Sprint for cellular phone service when their pricing is so much better?

20. 3. The proportion of the consumer's income the good represents
Goods which typically make up a small proportion of people's income will exhibit inelastic qualities. Conversely, goods which form a large proportion of people's income will cause greater responses in demand to comparable % increases or decreases in price.
For example, if cinema ticket costs rise by 20%, decreases in demand are unlikely to be pronounced.
However a 15% drop in a "luxury" good such as a car or LCD Television changes in demand are likely to be relatively greater.

21. 4. How closely the good is defined
Taking our example from (# 2), cigarettes in general are, as discussed, an inelastic good. However a particular brand of cigarettes will exhibit far more elastic properties if its price rises. In general therefore, the exact type of good will affect its PED properties.

22. 5. How closely the consumer (end-user) is defined?
This is an important factor intrinsically related to most of the preceding variables. "Choice" is very subjective and factors 1,2 and 3 vary relative to the individual consumer because every single consumer can potentially have a different Perceived Value of a good. A good that is easily replaceable or habit forming or expensive for one person may well not be for another and thus how well the consumer is defined will affect the PED.
At nationwide level, if the cost of butter rises significantly consumers can choose to consume margarine instead but a shop who makes and sells butter cookies will not have this option and thus the PED will be far more inelastic in the latter case.
A driver faced with rising petrol bills may opt to switch to using the train. However an airline company has no choice but to absorb rising fuel costs and will accordingly have a much more inelastic demand curve for essentially the same good.

23. 6. How closely the time period is defined
Generally the greater the time period, the more possible it may be for a good to be replaced with a substitute. Using home energy as an example, a gas user faced with rising gas bills will unlikely be able to switch to electric alternatives overnight due to possibly contractual tie-ins and time needed to change a gas stove to an electric for example. However over three months, a switch is far more viable and the PED will be accordingly more elastic. Likewise, prices are dynamic. Over short time periods, prices of substitutes maybe static, over longer periods, the price of substitutes may drop, making them more appealing. [Puiatti, 18: Nov-07]