ELASTICITY OF DEMAND Understand what it is Understand

ELASTICITY OF DEMAND • • • Understand what it is Understand the types of elasticity Understand the determinants Understand how it can change revenue Determine elasticity of products

• Which stretches or changes more—something that is elastic or inelastic?

ELASTICITY OF DEMAND • Main Ideas • Demand elasticity is the extent to which a change in price causes a change in the quantity demanded. • Demand is elastic when a change in price causes a relatively larger change in quantity demanded. • Demand is inelastic when a change in price causes a relatively smaller change in quantity demanded. • Demand is unit elastic when a change in price causes a proportional change in quantity demanded. • To measure the elasticity of demand, compare the percentage change in quantity demanded to the percentage change in price.

ELASTIC DEMAND • Refers to consumers being responsive to price changes • Demand curve very broad

INELASTIC DEMAND • Consumers unresponsive to price changes • Demand curve very steep

UNIT ELASTIC DEMAND • When a price change results in a proportional change in total expenditures, the demand is said to be unit elastic.

• What is the difference between elastic and inelastic demand? • Elastic demand means that a change in price of something like a food item causes a significant change in quantity demanded. Inelastic demand means that a change in price of something like medicine has a relatively small effect on quantity demanded

TOTAL EXPENDITURE TEST • Main Ideas • The total expenditures test compares the direction of a price change to the direction of change in total revenue or total expenditures. • With elastic demand, a change in price moves in the opposite direction from the change in revenue. • With unit elastic demand, there is no change in revenue, regardless of the price change. • With inelastic demand, the price and change in revenue move in the same direction. • Businesses often experiment with different prices for a new product to determine its demand elasticity; this allows the businesses to set a price that maximizes total revenues.

• What happens to the total expenditures for a product with elastic demand when its price goes up? • Total expenditures decrease because people buy less of the product when the price increases.

DETERMINANTS OF DEMAND ELASTICITY • Main Ideas • Demand is usually inelastic if consumers cannot postpone the purchase of a product. • When acceptable substitutes are available for a product, demand becomes more elastic. • Demand for purchases that require a large portion of income is generally more elastic than the demand for purchases that require a smaller amount of income.

INCOME • Small portion of income= inelastic demand • Ex: Condiments, Pens • Large portion of income=elastic demand • Ex: Appliances, Houses

NUMBER OF SUBSTITUTES • A lot of substitutes= elastic demand • Ex: Chevy cars, Tide • Few substitutes= inelastic demand • Ex: Gas, Salt

TIME PERIOD • Short time period = inelastic demand • Long time period = elastic demand

CHECKING YOU UNDERSTANDING • What type of demand elasticity do each of these products have—and why: • Soft drinks? • elastic; because substitutes exist • Salt? • inelastic; because the percentage of a person’s total budget devoted to the purchase of salt is relatively small • Steak? • elastic; because substitutes exist • Electric power? • inelastic; the purchase cannot be delayed in the short term