1. Elasticity of Demand

2. Definitions Elasticity: –The extent to which changes in price cause a change in quantity demanded or supplied. –How responsive quantity is to a price change. –How much consumers or suppliers care about price when making decisions. Elastic: –A price change causes a significant change in quantity demanded or supplied. (An elastic curve is less steep.) Inelastic: –A price change causes a small change in quantity demanded or supplied. (An inelastic curve is steeper.)

3. Elastic Demand Small price change Large change in quantity Original price and quantity New price and quantity

4. Inelastic Demand Large price change Small change in quantity Original price and quantity New price and quantity

5. Demand Elasticity Example of product with elastic demand: automobiles. –People care very much about price when deciding to buy. –A price decrease usually leads to a significant increase in quantity demanded. Example of product with inelastic demand: table salt. –People do not particularly care about price when deciding to buy. –A price decrease usually leads to a barely noticeable increase in quantity demanded.

6. Demand Elasticity and Market In the general market (all stations), the demand for gasoline is inelastic. –If the price goes up at all stations, people still have to buy gasoline. –Other products, however, may have elastic demand in the general market. In a specific market (one station), the demand for gasoline is actually elastic. –If the price goes up at one station, but not others, people simply go to the other stations. –Basically, ALL products have elastic demand in a specific market as long as there are other stores.

7. Estimating Demand Elasticity (for general market) There are 3 determinants of demand elasticity: –Can purchase be delayed? –Are there adequate substitutes? –Does purchase require a large portion of income? Hess’s Rule: $1000 or more = yes, $100 or less = no –If it is in between, use your best judgment.

8. Estimating Demand Elasticity (for general market), cont. For each question, yes means elastic, no means inelastic. Overall, 2-3 answers of yes means elastic, 2-3 answers of no means inelastic. Note: For items (like clothing) that are reusable for a long time (therefore most people have some already): –Yes, purchase can be delayed. –Yes, adequate substitutes are available.

9. Calculating Demand Elasticity Total receipts = price x quantity. As price goes down: –Increasing total receipts = elastic. –Decreasing total receipts = inelastic. –No change in total receipts = unit elastic.

10. Examples (Using handout 1A) 1.Between $27 and $24, is the demand for CDs elastic, inelastic, or unit elastic? –$27 x 10 = $270 (price x quantity = total receipts) –$24 x 13 = $312 –Since total receipts INCREASE as price goes down, demand is ELASTIC.

11. Examples, cont. 2. Between $6 and $3, is the demand for CDs elastic or inelastic? –$6 x 162 = $972 –$3 x 300 = $900 –Since total receipts DECREASE as price goes down, demand is INELASTIC.

12. Why Demand Elasticity Matters Demand elasticity will affect the degree of the price change WHEN THERE IS A CHANGE IN SUPPLY. –If demand is elastic, the price will not change much. Example: Hamburgers –If demand is inelastic, the price will change significantly. Example: Gasoline

13. Increase in Supply When Demand Is Elastic D S1 Original equilibrium S2 New equilibrium

14. Increase in Supply When Demand Is Inelastic DS1 Original equilibrium S2 New equilibrium