Table of Contents Access Prior Knowledge New Information Set Goals

Table of Contents Access Prior Knowledge New Information Set Goals
Activity Conclusion Elasticity Survey “Elasticity of Demand” Learning Targets The Price Elasticity of Demand Determining Elasticity “Elasticity of Demand” Learning Targets The Midpoint Method Coefficient of Elasticity Total Revenue Test Determinants of Elasticity Cross-Price Elasticity of Demand Income Elasticity of Demand

Elasticity Survey Decide if you would purchase each of these items at the indicated price. If yes, raise your hand when told to do so. Keep track of the survey results as they are written on the board. When the “New Price” is revealed, decide if you would pay this new price and raise your hand when told to do so. Go to the Survey

Coefficient of Elasticity
Elasticity Survey Original Price Original Demand New Price New Demand Coefficient of Elasticity Large Pizza $10 Smart Phone $500 Vacation to Europe $5,000 Ask students to raise their hands if they would be willing to pay $10 for their favorite pizza. Count the number of hands that are raised and write this number down in the first cell in the “Original Demand” column. Then perform the same survey for paying $500 for the Smart Phone and $5,000 for the Vacation to Europe. (If you are projecting the slideshow onto a whiteboard or SmartBoard, simply write the values on the screen. Otherwise, create a similar table nearby on the board.) Repeat Survey at the New Price

Elasticity Survey Original Price Original Demand New Price New Demand
Coefficient of Elasticity Large Pizza $10 Smart Phone $500 Vacation to Europe $5,000 $15 $750 $2,500 Now, perform the survey again using the new prices. Notice that the first two prices increased by 50% and the third price decreased by 50%. Write the survey results in the proper cells in the “New Demand” column. Calculate the Coefficient of Elasticity

(New Demand - Original Demand) / (Original Demand)
Elasticity Survey Original Price Original Demand New Price New Demand Coefficient of Elasticity Large Pizza $10 Smart Phone $500 Vacation to Europe $5,000 $15 $750 $2,500 Use this formula to show students how to compute the values for the the final column. Feel free to refer to this data for illustrative purposes as you go through the lecture. Calculate the “Coefficient of Elasticity” using this formula. (The denominator for all three is 50%.) % change in demand % change in price (New Demand - Original Demand) / (Original Demand) 0.5

“Elasticity of Demand” Targets
Knowledge Understand the difference between elastic and inelastic demand. Reasoning Determine whether items are elastic or inelastic using the determinants of elasticity. Skill Use formulas to calculate the price elasticity of demand, the cross-price elasticity of demand, and the income elasticity of demand.

The Price Elasticity of Demand
The elasticity of demand measures how much the quantity demanded will change when other factors change.

The elasticity of demand measures how much the quantity demanded will change when other factors change. 1) Price elasticity of demand measures how sensitive consumers are to a change in price. In the opening activity, we measured how sensitive you were to changes in price.

The elasticity of demand measures how much the quantity demanded will change when other factors change. 1) Price elasticity of demand measures how sensitive consumers are to a change in price. 2) Elastic demand means consumers are sensitive to a change in price. Consumers are highly sensitive to a change in price for a meal at a sit-down restaurant. They will consume much less even if the price rises just a little.

The elasticity of demand measures how much the quantity demanded will change when other factors change. 1) Price elasticity of demand measures how sensitive consumers are to a change in price. 2) Elastic demand means consumers are sensitive to a change in price. 3) Inelastic demand means consumers are not sensitive to a change in price. Consumers are not sensitive to a change in price for gasoline. They will consume only a little less even if the price rises a lot.

The elasticity of demand measures how much the quantity demanded will change when other factors change. 1) Price elasticity of demand measures how sensitive consumers are to a change in price. 2) Elastic demand means consumers are sensitive to a change in price. 3) Inelastic demand means consumers are not sensitive to a change in price. % change in quantity % change in price Price elasticity of demand 4) Elasticity equals the percent change in quantity demanded divided by the percent change in price.

The Midpoint Method When measuring percent changes, you will get a different result depending on which number you start with. The midpoint method eliminates this problem. For example: if we want to calculate the elasticity for pizza from the warm up activity, we know the original price was $10 and then it increased to $15. So the percent change in this case was 50%. Suppose, however, that we started at $15 and wanted to decrease the price to $10. This is not a 50% change; it is a 33% change. Thus, we get two different results for a percent change between the same two numbers. This is a nuisance, so economists use the midpoint method, which eliminates this problem. We will use this formula to calculate the price elasticity of demand. The midpoint method tells us how to calculate each “% change” properly. % change in quantity % change in price Price elasticity of demand

The Midpoint Method When measuring percent changes, you will get a different result depending on which number you start with. The midpoint method eliminates this problem. 1) Formula to find the numerator: Change in quantity Average quantity % change in quantity % change in quantity % change in price Price elasticity of demand

The Midpoint Method When measuring percent changes, you will get a different result depending on which number you start with. The midpoint method eliminates this problem. 1) Formula to find the numerator: Example Change in quantity Average quantity % change in quantity Price (P) Quantity Demanded (Q) Situation 1 $3 12 Situation 2 $5 8 2) Numerator formula rewritten: Q2 - Q1 (Q1 + Q2) / 2 % change in quantity Calculate % change in quantity There is space on the student note sheet to copy the formulas and follow along with the example. % change in quantity % change in price Price elasticity of demand

The Midpoint Method When measuring percent changes, you will get a different result depending on which number you start with. The midpoint method eliminates this problem. 1) Formula to find the numerator: Example Change in quantity Average quantity % change in quantity Price (P) Quantity Demanded (Q) Situation 1 $3 12 Situation 2 $5 8 2) Numerator formula rewritten: Q2 - Q1 (Q1 + Q2) / 2 % change in quantity 8 - 12 (12 + 8) / 2 - 4 10 - 0.4 % change in quantity % change in price Price elasticity of demand

The Midpoint Method When measuring percent changes, you will get a different result depending on which number you start with. The midpoint method eliminates this problem. 1) Formula to find the numerator: Example Change in quantity Average quantity % change in quantity Price (P) Quantity Demanded (Q) Situation 1 $3 12 Situation 2 $5 8 2) Numerator formula rewritten: Q2 - Q1 (Q1 + Q2) / 2 % change in quantity 8 - 12 (12 + 8) / 2 - 4 10 - 0.4 3) Denominator has a similar formula: P2 - P1 (P1 + P2) / 2 % change in price Calculate % change in price % change in quantity % change in price Price elasticity of demand

The Midpoint Method When measuring percent changes, you will get a different result depending on which number you start with. The midpoint method eliminates this problem. 1) Formula to find the numerator: Example Change in quantity Average quantity % change in quantity Price (P) Quantity Demanded (Q) Situation 1 $3 12 Situation 2 $5 8 2) Numerator formula rewritten: Q2 - Q1 (Q1 + Q2) / 2 % change in quantity 8 - 12 (12 + 8) / 2 - 4 10 - 0.4 3) Denominator has a similar formula: P2 - P1 (P1 + P2) / 2 % change in price $5 - $3 ($3 + $5) / 2 $2 $4 0.5 % change in quantity % change in price Price elasticity of demand

Complete the Final Step
The Midpoint Method When measuring percent changes, you will get a different result depending on which number you start with. The midpoint method eliminates this problem. 1) Formula to find the numerator: Example Change in quantity Average quantity % change in quantity Price (P) Quantity Demanded (Q) Situation 1 $3 12 Situation 2 $5 8 2) Numerator formula rewritten: Q2 - Q1 (Q1 + Q2) / 2 % change in quantity 8 - 12 (12 + 8) / 2 - 4 10 - 0.4 3) Denominator has a similar formula: P2 - P1 (P1 + P2) / 2 % change in price $5 - $3 ($3 + $5) / 2 $2 $4 0.5 4) This is the complete formula: Q2 - Q1 (Q1 + Q2) / 2 PED P2 - P1 (P1 + P2) / 2 ÷ Complete the Final Step

The Midpoint Method When measuring percent changes, you will get a different result depending on which number you start with. The midpoint method eliminates this problem. 1) Formula to find the numerator: Example Change in quantity Average quantity % change in quantity Price (P) Quantity Demanded (Q) Situation 1 $3 12 Situation 2 $5 8 2) Numerator formula rewritten: Q2 - Q1 (Q1 + Q2) / 2 % change in quantity 8 - 12 (12 + 8) / 2 - 4 10 - 0.4 3) Denominator has a similar formula: P2 - P1 (P1 + P2) / 2 % change in price $5 - $3 ($3 + $5) / 2 $2 $4 0.5 Note that economists usually drop the negative sign at this final stage. All demand elasticities are negative by definition, so the negative sign is understood. Also, it is a good idea to give students another sample problem at this point so they get some more practice. If you need some numbers, try these. Situation 1 is $9 with a quantity of 9. Situation 2 is $11 with a quantity of 7. 4) This is the complete formula: Q2 - Q1 (Q1 + Q2) / 2 PED P2 - P1 (P1 + P2) / 2 ÷ - 0.4 PED ÷ 0.5 - 0.8

The values we get when we calculate the price elasticity of demand are called coefficients of elasticity. They tell us the relative elasticity of an item. All price elasticities of demand are negative by definition (or zero). Economists usually drop the negative signs, however, for simplicity.

The values we get when we calculate the price elasticity of demand are called coefficients of elasticity. They tell us the relative elasticity of an item. 1) Coefficient Is Zero Perfectly inelastic demand: Consumers pay no attention to price. D When demand is perfectly inelastic, its graph is a vertical line. Any change in price has no effect on quantity.

The values we get when we calculate the price elasticity of demand are called coefficients of elasticity. They tell us the relative elasticity of an item. 1) Coefficient Is Zero Perfectly inelastic demand: Consumers pay no attention to price. D D 2) Coefficient Is Between 0 and 1 Inelastic demand: Consumers are not sensitive to price. Inelastic demand is relatively steep. Notice how even a large change in price has had only a minimal effect on quantity.

The values we get when we calculate the price elasticity of demand are called coefficients of elasticity. They tell us the relative elasticity of an item. 1) Coefficient Is Zero Perfectly inelastic demand: Consumers pay no attention to price. D D 2) Coefficient Is Between 0 and 1 Inelastic demand: Consumers are not sensitive to price. 3) Coefficient Is 1 Unit elastic demand: Demand is not elastic or inelastic. The two regions on the graph do not look identical in size because the x-axis and y-axis do not have the same proportions. The graph is, indeed, unit elastic between $4 and $6. It is also important to note that most demand graphs have elastic and inelastic portions. This is further discussed in the “Total Revenue Test” section. Unit elastic demand shows an equal change in price and quantity. Using the midpoint method, price has changed by 40% and quantity has changed by 40%.

The values we get when we calculate the price elasticity of demand are called coefficients of elasticity. They tell us the relative elasticity of an item. 1) Coefficient Is Zero Perfectly inelastic demand: Consumers pay no attention to price. D D 2) Coefficient Is Between 0 and 1 Inelastic demand: Consumers are not sensitive to price. 3) Coefficient Is 1 Unit elastic demand: Demand is not elastic or inelastic. 4) Coefficient Is Greater Than 1 Elastic demand: Consumers are sensitive to price. Elastic demand is relatively flat. Notice how only a small change in price has had a large effect on quantity.

The values we get when we calculate the price elasticity of demand are called coefficients of elasticity. They tell us the relative elasticity of an item. 1) Coefficient Is Zero Perfectly inelastic demand: Consumers pay no attention to price. D D 2) Coefficient Is Between 0 and 1 Inelastic demand: Consumers are not sensitive to price. 3) Coefficient Is 1 Unit elastic demand: Demand is not elastic or inelastic. 4) Coefficient Is Greater Than 1 Elastic demand: Consumers are sensitive to price. 5) Coefficient Is Infinite Perfectly elastic demand is a horizontal line. Any rise in price will eliminate all demand. The coefficient is infinite since you must divide by zero in the formula. Perfectly elastic demand: Price changes infinitely affect quantity.

Total Revenue Test Each section of a demand curve has a different elasticity. The Total Revenue Test, which also calculates elasticity, shows how this works. The Total Revenue Test is an important application of elasticity. If demand is inelastic, a firm can make more money by raising prices, and if demand is elastic, they can make more money by lowering prices.

Total Revenue Test 1) Calculations
Each section of a demand curve has a different elasticity. The Total Revenue Test, which also calculates elasticity, shows how this works. 1) Calculations A) Total Revenue = Price x Quantity The top graph is a regular demand curve. The bottom graph shows total revenue for each of the corresponding quantities from the top graph.

Each section of a demand curve has a different elasticity. The Total Revenue Test, which also calculates elasticity, shows how this works. 1) Calculations A) Total Revenue = Price x Quantity B) Calculate total revenue for the original price and quantity. For example, suppose the firm in this market has a price of $1 and a quantity of 9. The total revenue in this situation is $9.

Each section of a demand curve has a different elasticity. The Total Revenue Test, which also calculates elasticity, shows how this works. 1) Calculations A) Total Revenue = Price x Quantity B) Calculate total revenue for the original price and quantity. C) Calculate total revenue for the new price and quantity. Now, suppose the price increases to $2 and the quantity drops to 8. Total revenue is now $16. This firm has increased its revenue by increasing price.

Total Revenue Test 1) Calculations 2) Results
Each section of a demand curve has a different elasticity. The Total Revenue Test, which also calculates elasticity, shows how this works. Inelastic 1) Calculations A) Total Revenue = Price x Quantity B) Calculate total revenue for the original price and quantity. C) Calculate total revenue for the new price and quantity. 2) Results A) INELASTIC: total revenue moved in the same direction as price. Notice that this firm will increase its revenue as long as it keeps increasing its price up to $5. Price and revenue are moving in the same direction.

Each section of a demand curve has a different elasticity. The Total Revenue Test, which also calculates elasticity, shows how this works. Elastic Inelastic 1) Calculations A) Total Revenue = Price x Quantity B) Calculate total revenue for the original price and quantity. C) Calculate total revenue for the new price and quantity. 2) Results A) INELASTIC: total revenue moved in the same direction as price. B) ELASTIC: total revenue moved in the opposite direction as price. Notice that as price increases beyond $5, total revenue gets smaller. Price and revenue are moving in opposite directions.

Each section of a demand curve has a different elasticity. The Total Revenue Test, which also calculates elasticity, shows how this works. Elastic Unit Elastic Inelastic 1) Calculations A) Total Revenue = Price x Quantity B) Calculate total revenue for the original price and quantity. C) Calculate total revenue for the new price and quantity. 2) Results A) INELASTIC: total revenue moved in the same direction as price. B) ELASTIC: total revenue moved in the opposite direction as price. When total revenue reaches its maximum, the demand is unit elastic. Notice that moving from $4 to $6, for example, does not change total revenue. C) UNIT ELASTIC: total revenue did not change.

Determinants of Elasticity
Several factors help determine whether an item is relatively elastic or inelastic. There are other factors that can contribute to item’s elasticity. Only four have been included here for simplicity. Determinants of elasticity not included are: 1) Transaction costs - if there is a high cost of switching to a substitute product, then demand is inelastic. 2) Addictive level of item - items such as cigarettes are addictive and, therefore, inelastic. 3) Breadth of definition of the item - if defining a market broadly, such as the market for food, the item is inelastic. As the market gets more specific, such as whole grain cereal, the item becomes much more elastic.

Several factors help determine whether an item is relatively elastic or inelastic. 1) Items Are Elastic If… A) Substitutes exist and are readily available. Pizza restaurants have many competitors and, thus, many substitutes. If one chain raises their prices, consumers can easily find a substitute.

Several factors help determine whether an item is relatively elastic or inelastic. 1) Items Are Elastic If… A) Substitutes exist and are readily available. B) The item represents a large portion of a person’s income. For most people, airline travel is extremely costly. Although flying has few substitutes, many people will simply choose not to travel if prices are too high.

Several factors help determine whether an item is relatively elastic or inelastic. 1) Items Are Elastic If… A) Substitutes exist and are readily available. B) The item represents a large portion of a person’s income. C) The item is a luxury. Food in general is a very inelastic item. When discussing the market for restaurant food, however, the good is considered a luxury and is thus elastic.

Several factors help determine whether an item is relatively elastic or inelastic. 1) Items Are Elastic If… A) Substitutes exist and are readily available. B) The item represents a large portion of a person’s income. C) The item is a luxury. D) Consumers have a lot of time to adjust to a change in price. Gasoline is inelastic in the short run but is elastic in the long run. This is because consumers will find alternative fuels and adjust their habits if given time.

Several factors help determine whether an item is relatively elastic or inelastic. 1) Items Are Elastic If… A) Substitutes exist and are readily available. B) The item represents a large portion of a person’s income. C) The item is a luxury. D) Consumers have a lot of time to adjust to a change in price. 2) Items Are Inelastic If… A) Substitutes are hard to find or may not exist. Electricity is a necessary good for most people. If the price of electricity increases, we may complain about it, but we will certainly pay it.

Several factors help determine whether an item is relatively elastic or inelastic. 1) Items Are Elastic If… A) Substitutes exist and are readily available. B) The item represents a large portion of a person’s income. C) The item is a luxury. D) Consumers have a lot of time to adjust to a change in price. 2) Items Are Inelastic If… A) Substitutes are hard to find or may not exist. B) The item is a small portion of a person’s income. A cup of coffee generally costs very little. Thus, even large percentage increases in price may go largely unnoticed by the consumer.

Several factors help determine whether an item is relatively elastic or inelastic. 1) Items Are Elastic If… A) Substitutes exist and are readily available. B) The item represents a large portion of a person’s income. C) The item is a luxury. D) Consumers have a lot of time to adjust to a change in price. 2) Items Are Inelastic If… A) Substitutes are hard to find or may not exist. B) The item is a small portion of a person’s income. Consumers often have little choice about whether or not to take a prescription medication. They will pay almost any price if it means feeling healthy. C) The item is a necessity.

Several factors help determine whether an item is relatively elastic or inelastic. 1) Items Are Elastic If… A) Substitutes exist and are readily available. B) The item represents a large portion of a person’s income. C) The item is a luxury. D) Consumers have a lot of time to adjust to a change in price. 2) Items Are Inelastic If… A) Substitutes are hard to find or may not exist. Notice that gasoline can be considered both elastic or inelastic depending on the time frame being discussed. Most items are more inelastic in the short run and more elastic in the long run. B) The item is a small portion of a person’s income. Consumers may be able to find alternative fuels and adjust their habits in the long run, but they are not sensitive to increases in gas prices in the short run. C) The item is a necessity. D) Consumers have little time to adjust to a change in price.

Cross-Price Elasticity of Demand
Another type of elasticity is the cross-price elasticity of demand, which measures how strongly two substitutes or two complements are related.

Another type of elasticity is the cross-price elasticity of demand, which measures how strongly two substitutes or two complements are related. 1) We use a slightly different formula: Example % change in quantity of A % change in price of B Cross elasticity of demand Item A P Q Situation 1 $12 14 Situation 2 $10 18 Item B P Q Situation 1 $19 34 Situation 2 $21 30

Another type of elasticity is the cross-price elasticity of demand, which measures how strongly two substitutes or two complements are related. 1) We use a slightly different formula: Example % change in quantity of A % change in price of B Cross elasticity of demand Item A P Q Situation 1 $12 14 Situation 2 $10 18 Item B P Q Situation 1 $19 34 Situation 2 $21 30 2) Still use the midpoint method for calculating each percent change. Calculate % change in quantity of A

Another type of elasticity is the cross-price elasticity of demand, which measures how strongly two substitutes or two complements are related. 1) We use a slightly different formula: Example % change in quantity of A % change in price of B Cross elasticity of demand Item A P Q Situation 1 $12 14 Situation 2 $10 18 Item B P Q Situation 1 $19 34 Situation 2 $21 30 2) Still use the midpoint method for calculating each percent change. Calculate the value of the numerator ( ) / 2 4 16 0.25 Calculate % change in price of B

Another type of elasticity is the cross-price elasticity of demand, which measures how strongly two substitutes or two complements are related. 1) We use a slightly different formula: Example % change in quantity of A % change in price of B Cross elasticity of demand Item A P Q Situation 1 $12 14 Situation 2 $10 18 Item B P Q Situation 1 $19 34 Situation 2 $21 30 2) Still use the midpoint method for calculating each percent change. Calculate the value of the numerator ( ) / 2 4 16 0.25 Calculate the value of the denominator $21 - $19 ($19 + $21) / 2 $2 $20 0.1 Complete the Final Step

Another type of elasticity is the cross-price elasticity of demand, which measures how strongly two substitutes or two complements are related. 1) We use a slightly different formula: Example % change in quantity of A % change in price of B Cross elasticity of demand Item A P Q Situation 1 $12 14 Situation 2 $10 18 Item B P Q Situation 1 $19 34 Situation 2 $21 30 2) Still use the midpoint method for calculating each percent change. Calculate the value of the numerator ( ) / 2 4 16 0.25 Calculate the value of the denominator $21 - $19 ($19 + $21) / 2 $2 $20 0.1 Divide numerator by denominator 0.25 CED ÷ 0.1 2.5

Another type of elasticity is the cross-price elasticity of demand, which measures how strongly two substitutes or two complements are related. 1) We use a slightly different formula: Example % change in quantity of A % change in price of B Cross elasticity of demand Item A P Q Situation 1 $12 14 Situation 2 $10 18 Item B P Q Situation 1 $19 34 Situation 2 $21 30 2) Still use the midpoint method for calculating each percent change. Calculate the value of the numerator ( ) / 2 4 16 0.25 3) Goods with positive cross-price elasticities are substitutes. Calculate the value of the denominator Notice that the example had a positive cross-price elasticity above 1. This indicates that these two items are fairly strong substitutes for each other. Cross-price elasticities above 1 or below -1 usually indicate a strong relationship. $21 - $19 ($19 + $21) / 2 $2 $20 0.1 Divide numerator by denominator 0.25 CED ÷ 0.1 2.5

Another type of elasticity is the cross-price elasticity of demand, which measures how strongly two substitutes or two complements are related. 1) We use a slightly different formula: Example % change in quantity of A % change in price of B Cross elasticity of demand Item A P Q Situation 1 $12 14 Situation 2 $10 18 Item B P Q Situation 1 $19 34 Situation 2 $21 30 2) Still use the midpoint method for calculating each percent change. Calculate the value of the numerator ( ) / 2 4 16 0.25 3) Goods with positive cross-price elasticities are substitutes. Calculate the value of the denominator When calculating cross-price elasticities of demand, it is very important not to drop the negative sign because the negative sign determines whether the two items are substitutes or complements. $21 - $19 ($19 + $21) / 2 $2 $20 0.1 4) Goods with negative cross-price elasticities are complements. Divide numerator by denominator 0.25 CED ÷ 0.1 2.5

Another type of elasticity is the cross-price elasticity of demand, which measures how strongly two substitutes or two complements are related. 1) We use a slightly different formula: Example % change in quantity of A % change in price of B Cross elasticity of demand Item A P Q Situation 1 $12 14 Situation 2 $10 18 Item B P Q Situation 1 $19 34 Situation 2 $21 30 2) Still use the midpoint method for calculating each percent change. Calculate the value of the numerator ( ) / 2 4 16 0.25 3) Goods with positive cross-price elasticities are substitutes. Calculate the value of the denominator $21 - $19 ($19 + $21) / 2 $2 $20 0.1 4) Goods with negative cross-price elasticities are complements. Divide numerator by denominator 5) Cross-price elasticities near zero mean the goods are unrelated. 0.25 CED ÷ 0.1 2.5

Income Elasticity of Demand
Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes.

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes. 1) We use a slightly different formula: Example % change in quantity % change in income Income elasticity of demand P Q Situation 1 $25 45 Situation 2 $21 55 Income Situation 1 $700 Situation 2 $900

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes. 1) We use a slightly different formula: Example % change in quantity % change in income Income elasticity of demand P Q Situation 1 $25 45 Situation 2 $21 55 Income Situation 1 $700 Situation 2 $900 2) Still use the midpoint method for calculating each percent change. Calculate % change in quantity

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes. 1) We use a slightly different formula: Example % change in quantity % change in income Income elasticity of demand P Q Situation 1 $25 45 Situation 2 $21 55 Income Situation 1 $700 Situation 2 $900 2) Still use the midpoint method for calculating each percent change. Calculate the value of the numerator ( ) / 2 10 50 0.2 Calculate % change in income

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes. 1) We use a slightly different formula: Example % change in quantity % change in income Income elasticity of demand P Q Situation 1 $25 45 Situation 2 $21 55 Income Situation 1 $700 Situation 2 $900 2) Still use the midpoint method for calculating each percent change. Calculate the value of the numerator ( ) / 2 10 50 0.2 Calculate the value of the denominator $900 - $700 ($700 + $900) / 2 $200 $800 0.25 Complete the Final Step

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes. 1) We use a slightly different formula: Example % change in quantity % change in income Income elasticity of demand P Q Situation 1 $25 45 Situation 2 $21 55 Income Situation 1 $700 Situation 2 $900 2) Still use the midpoint method for calculating each percent change. Calculate the value of the numerator ( ) / 2 10 50 0.2 Calculate the value of the denominator $900 - $700 ($700 + $900) / 2 $200 $800 0.25 Divide numerator by denominator 0.2 IED ÷ 0.25 0.8

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes. 1) We use a slightly different formula: Example % change in quantity % change in income Income elasticity of demand P Q Situation 1 $25 45 Situation 2 $21 55 Income Situation 1 $700 Situation 2 $900 2) Still use the midpoint method for calculating each percent change. Calculate the value of the numerator ( ) / 2 10 50 0.2 3) Normal goods have positive income elasticities. Calculate the value of the denominator When calculating income elasticities of demand, it is very important not to drop the negative sign because the negative sign determines whether the item is a normal good or an inferior good. $900 - $700 ($700 + $900) / 2 $200 $800 0.25 Divide numerator by denominator 0.2 IED ÷ 0.25 0.8

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes. 1) We use a slightly different formula: Example % change in quantity % change in income Income elasticity of demand P Q Situation 1 $25 45 Situation 2 $21 55 Income Situation 1 $700 Situation 2 $900 2) Still use the midpoint method for calculating each percent change. Calculate the value of the numerator ( ) / 2 10 50 0.2 3) Normal goods have positive income elasticities. Calculate the value of the denominator 4) If below 1, it is income-inelastic: demand rises slower than income. Items that are income inelastic tend to be necessities. People will purchase these items even if their incomes are low, which means they will not need to purchase too much more if their incomes rise significantly. Income-inelastic items tend to be things like food and clothing. $900 - $700 ($700 + $900) / 2 $200 $800 0.25 Divide numerator by denominator 0.2 IED ÷ 0.25 0.8

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes. 1) We use a slightly different formula: Example % change in quantity % change in income Income elasticity of demand P Q Situation 1 $25 45 Situation 2 $21 55 Income Situation 1 $700 Situation 2 $900 2) Still use the midpoint method for calculating each percent change. Calculate the value of the numerator ( ) / 2 10 50 0.2 3) Normal goods have positive income elasticities. Calculate the value of the denominator 4) If below 1, it is income-inelastic: demand rises slower than income. Items that are income elastic tend to be luxuries. People purchase relatively few of these items at low incomes, which means they will purchase a great deal more if their incomes rise significantly. Examples of income-elastic items include expensive cars and second homes. $900 - $700 ($700 + $900) / 2 $200 $800 0.25 5) If above 1, it is income-elastic: demand rises faster than income. Divide numerator by denominator 0.2 IED ÷ 0.25 0.8

Another type of elasticity is the income elasticity of demand, which measures how much quantity changes when consumer income changes. 1) We use a slightly different formula: Example % change in quantity % change in income Income elasticity of demand P Q Situation 1 $25 45 Situation 2 $21 55 Income Situation 1 $700 Situation 2 $900 2) Still use the midpoint method for calculating each percent change. Calculate the value of the numerator ( ) / 2 10 50 0.2 3) Normal goods have positive income elasticities. Calculate the value of the denominator 4) If below 1, it is income-inelastic: demand rises slower than income. A negative income elasticity indicates that demand is inversely related to income. Thus, if income increases, the quantity demanded will drop and vice versa. This is the definition of an inferior good. $900 - $700 ($700 + $900) / 2 $200 $800 0.25 5) If above 1, it is income-elastic: demand rises faster than income. Divide numerator by denominator 0.2 IED ÷ 0.25 0.8 6) Inferior goods have negative income elasticities.

Determining Elasticity
DETERMINANTS OF ELASTICITY The table lists the characteristics of an item that is elastic (first column) and the characteristics of an item that is inelastic (second column). In the problems that follow, first identify whether the item is elastic or inelastic. Then, write down the letter(s) from the table that lists the proper explanation. THE PRICE ELASTICITY OF DEMAND Use the formula for the price elasticity of demand to solve these problems. Remember, coefficients below 1 are inelastic; coefficients equal to 1 are unit elastic; and coefficients greater than 1 are elastic. TOTAL REVENUE TEST Use the Total Revenue Test to solve these problems. Remember, if total revenue moves in the same direction as price, it is inelastic; if total revenue stays the same, it is unit elastic; and if total revenue moves in the opposite direction as price, it is elastic. These are the directions for the Class Activity that is included in the download. You may differentiate instruction by using the three different versions, or you may decide to simply use just one version for the whole class.

“Elasticity of Demand” Targets
Knowledge Understand the difference between elastic and inelastic demand. Reasoning Determine whether items are elastic or inelastic using the determinants of elasticity. Skill Use formulas to calculate the price elasticity of demand, the cross-price elasticity of demand, and the income elasticity of demand.

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Table of Contents Access Prior Knowledge New Information Set Goals

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