Elasticity of Demand- Micro Topic 2.3

Law of Demand

• Definition: Inverse relationship between price and quantity demanded.

  • Price Increase: Leads to a decrease in quantity demanded.

  • Price Decrease: Leads to an increase in quantity demanded.

Elasticity of Demand

• Definition: Measures how sensitive the quantity demanded is to a change in price.

• Elastic vs Inelastic Demand:

  • Inelastic Demand:

    • Example: Gasoline.

    • Characteristics:

      • Quantity demanded changes little with price changes.

      • Few substitutes available.

      • Considered a necessity.

      • Elasticity coefficient < 1 (<1).

    • Formula: Elasticity = Percent Change in Quantity / Percent Change in Price.

    • Absolute value is used in calculations due to the inverse nature of price and quantity changes.

  • Elastic Demand:

    • Characteristics:

      • Quantity demanded changes significantly with price changes.

      • Many substitutes available or luxury items.

      • Elasticity coefficient > 1 (>1).

• Unit Elastic Demand:

  • Definition: Percent change in quantity demanded is equal to the percent change in price.

  • Example: If price increases by 20%, quantity decreases by 20%. Elasticity coefficient = 1.

Types of Demand Curves

• Perfectly Inelastic Demand:

  • Definition: No change in quantity demanded despite price changes.

  • Elasticity coefficient = 0.

• Perfectly Elastic Demand:

  • Definition: Consumers will only buy at one price; no sales at higher prices.

  • Elasticity coefficient = ∞ (infinity).

Total Revenue Test

• Definition: Analyzes how total revenue changes with price changes based on the elasticity of demand.

• Elasticity Implications:

  • Inelastic Demand:

    • Price increase leads to an increase in total revenue (box size increases).

    • Price decrease leads to a decrease in total revenue.

    • Example: Gas stations avoid sales, as lower prices reduce revenue.

  • Elastic Demand:

    • Price increase leads to a decrease in total revenue (box size decreases).

    • Price decrease leads to an increase in total revenue.

    • Example: Sales offered for elastic goods to boost revenue.

Practical Test Considerations

• Scenario: If price increases and total revenue decreases, it indicates elastic demand.

• Mnemonic Device for Total Revenue Test:

  • To remember:

    • "Price up, total revenue up" creates an "I" (Inelastic demand).

    • "Price down, total revenue down" also creates an "I" (Inelastic demand).

    • "Price up, total revenue down" does NOT create an "I" (Elastic demand).

    • "Price down, total revenue up" does NOT create an "I" (Elastic demand).

Conclusion

• Review concepts of elasticity and total revenue for success in economics.

• Upcoming topics include cross-price elasticity and income elasticity.