Elasticity of Demand E. 21.

Elasticity of Demand E. 21

Objectives Students will…
Distinguish between elastic and inelastic demand Determine whether items are elastic or inelastic using the determinants of elasticity Use formulas to calculate the price elasticity of demand, the cross-price elasticity of demand, and the income elasticity of demand.

Warm Up 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.

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.)

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 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. $2,500

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

The Price Elasticity of Demand The elasticity of demand measures how much the quantity demanded will change when other factors change… Price Elasticity of Demand measures how sensitive consumers are to a change in price. 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. Inelastic demand means consumers are not sensitive to a change in price. Consumers are not sensitive to a change in price of gas. They will consumer only a little less even if prices rise a lot. % change in quantity % change in price Price of demand elasticity

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.

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.

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.

Group Discussion In groups of 4, discuss the questions on the following slide

The two most common products to offer coupons in the newspaper are breakfast cereals and household cleaners. What is it about those goods that leads their manufacturers to offer coupons? Are there any other products that frequently have coupons that fit this explanation? Why would sellers who are interested in maximizing profits decide to lower the price of the good they are selling? How is a coupon different than just lowering the price? Advantage for the seller? What is probably true of those who look for and use coupons? How does this discussion relate to why you can purchase a ticket to fly on the very same flight on the very same plane for less if you buy it a month in advance than if you buy it 3 days before, and if you stay over a Saturday night?

“Now I Get It” Question How does this discussion help explain why each of you will have differing amounts of financial aid to attend college?

Assessment Which of the following best describes why pizza from one particular restaurant is elastic? Substitutes are readily available The item represents a large portion of a person’s income The item is a luxury Consumers have a lot of time to adjust to change in price Which of the following best describes why phone service from one carrier is inelastic one day after a 50% price increase? Substitutes are hard to find or may not exist The item is a small portion of the person’s income Item is a necessity Consumers have little time to adjust to change in price When the PED is relatively elastic, it means The item is an inferior good The two items are complements Consumers are sensitive to changes in price Consumers are not sensitive to changes in price When the PED is relatively inelastic, it means The item is a normal good The two items are substitutes

Assessment Part II When a good costs $2, the quantity sold is 25. When the price is raised to $6, the quantity sold drops to 15. Use the formula below to determine the coefficient of elasticity. (Negative signs have been omitted.) 0.25 0.5 1 2 PED = Q2 – Q1 (Q1 + Q2) /2 P2 – P1 (P1 + P2)/2

Elasticity of Demand E. 21.

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