Unit 2 Supply and Demand Copyright ACDC Leadership

Unit 2: Supply and Demand Copyright ACDC Leadership 2019 1

Topic 2. 3 Price Elasticity of Demand Copyright ACDC Leadership 2019

Why do furniture stores have sales all the time but gas stations rarely have sales? 5

The Law of Demand says. . . Consumers will buy more when prices go down and less when prices go up Elasticity is about determining how much more or how much less Copyright ACDC Leadership 2019 6

Price Elasticity of Demand (PED) Measures how sensitive quantity demanded is to a change in price Copyright ACDC Leadership 2019 7

Imagine that the prices of each of the following goods doubles. How would the price increase affect the quantity demanded? Taco Bell Tacos Medicine Gasoline Luxury Yachts Milk Copyright ACDC Leadership 2019 8

Price Elasticity of Demand (PED) Knowing how consumers will respond to a change in price is extremely useful to firms Why does elasticity matter? • It helps them decide what to charge and when, if ever, to have sales • It helps them determine how many substitutes are in the market • It is also used by the government to decide when and how much to tax Copyright ACDC Leadership 2019 9

Inelastic Demand Copyright ACDC Leadership 2019 10

Inelastic Demand INelastic Demand= Quantity is INsensitive to a change in price. • If price increases, quantity 20% demanded will fall a little • If price decreases, quantity demanded increases a little. In other words, people will continue to buy it. 5% An INELASTIC demand curve is steep! (looks like an “I”) Copyright ACDC Leadership 2019 Examples: • Gasoline • Milk • Diapers • Chewing Gum • Medical Care • Toilet paper 11

Based on the examples of inelastic goods, can you identify the characteristics of INelastic goods? Copyright ACDC Leadership 2019 12

Inelastic Demand General Characteristics of INelastic Goods: 20% 1. Few Substitutes 2. Necessities 3. Small portion of income 4. Required now, rather than later 5. Elasticity coefficient less than 1 Copyright ACDC Leadership 2019 5% 13

Elastic Demand Copyright ACDC Leadership 2019 14

Elastic Demand = Quantity is sensitive to a change in price. • If price increases, quantity demanded will fall a lot • If price decreases, quantity demanded increases a lot. In other words, the amount people buy is sensitive to price. An ELASTIC demand curve is flat! Copyright ACDC Leadership 2019 Examples: • Soda • Boats • Beef • Real Estate • Pizza • Gold 15

Elastic Demand General Characteristics of Elastic Goods: 1. Many Substitutes 2. Luxuries 3. Large portion of income 4. Plenty of time to decide 5. Elasticity coefficient greater than 1 Copyright ACDC Leadership 2019 16

Elastic or Inelastic? Beef. Gasoline. Real Estate. Medical Care. Electricity. Gold- Elastic -1. 27 INelastic -. 20 Elastic -1. 60 INelastic -. 31 INelastic -. 13 Elastic -2. 6 Perfectly INELASTIC (Coefficient = 0) Copyright ACDC Leadership 2019 What about the demand for insulin for diabetics? What if % change in quantity demanded equals % change in price? Unit Elastic (Coefficient =1) 18

Elasticity Visualized D D D Perfectly Inelastic Relatively Inelastic Unit Elastic Relatively Elastic Perfectly Elasticity Coefficient Elasticity Coefficient 0 <1 >1 ∞ Coefficient 1 The elasticity of demand coefficient is always negative. Copyright These numbers are the ABSOLUTE VALUE ACDC Leadership 2019 20

There is another way to determine the elasticity of demand for a good. Copyright ACDC Leadership 2019 21

Total Revenue (P x Q) Relatively Inelastic Demand Relatively Elastic Demand D 1. What happens to quantity for each when price increases? 2. What happens to total revenue for each when price increases? Copyright ACDC Leadership 2019 D 22

Total Revenue Test Uses elasticity to show changes in price will affect total revenue (TR). Ex: If the demand for gas is inelastic, what will happen to total revenue for gas stations if price increases? Inelastic Demand • Price increase causes TR to increase • Price decrease causes TR to decrease Elastic Demand • Price increase causes TR to decrease • Price decrease causes TR to increase Unit Elastic • Price changes and TR remains unchanged Copyright ACDC Leadership 2019 23

Is the range between A and B, elastic, inelastic, or unit elastic? 10 x 100 =$1000 Total Revenue 5 x 225 =$1125 Total Revenue A 50% B Price decreased and TR increased, so… Demand is ELASTIC 125% Copyright ACDC Leadership 2019 24