Elasticity+of+Demand

Price Elasticity of Demand

Page 1: Introduction

• Price Elasticity of Demand: A measure of how much the quantity demanded of a good responds to a change in the price of that good.

Page 2: Difference between Elastic and Inelastic

• Elastic Demand:

  • Quantity demanded responds significantly to price changes.

• Inelastic Demand:

  • Quantity demanded responds minimally to price changes.

Page 3: Inelastic Demand

• Characteristics:

  • Price increases lead to a small decrease in the quantity demanded.

  • Price decreases lead to a small increase in the quantity demanded.

• Examples:

  • Gasoline

  • Milk

  • Diapers

  • Chewing Gum

  • Medical Care

  • Toilet Paper

• Visual Representation:

  • An inelastic demand curve is steep (resembles an "I").

Page 4: Elastic Demand

• Characteristics:

  • Price increases lead to a significant decrease in the quantity demanded.

  • Price decreases lead to a significant increase in the quantity demanded.

• Examples:

  • Soda

  • Boats

  • Beef

  • Real Estate

  • Pizza

  • Gold

• Visual Representation:

  • Elastic demand curve is flat.

Page 5: Definition and Formula

• Price Elasticity of Demand:

  • Formula:

    • % change in Quantity Demanded / % change in Price

• Elasticity Coefficients:

  • 1: Elastic

  • = 1: Unit Elastic

  • 0.01 - 0.99: Inelastic

  • 0: Perfectly Inelastic

  • ∞: Perfectly Elastic

• Note: The elasticity of demand coefficient is always negative; consider absolute values.

Page 6: Elasticity Visualized

• Elasticity Coefficients:

  • Perfectly Inelastic: 0

  • Relatively Inelastic: < 1

  • Unit Elastic: 1

  • Relatively Elastic: > 1

  • Perfectly Elastic: ∞

Page 7: Total Revenue Test (TR)

• Formula:

  • Price x Quantity = Total Revenue (TR)

• Testing Method:

  • Requires two different quantities and two different prices.

• Interpretation:

  • Same direction: Inelastic

  • Opposite direction: Elastic

  • Unchanged TR: Unit Elastic

Page 8: Other Elasticity Formulas (AP ECON)

• Income Elasticity of Demand:

  • Formula:

    • % change in Quantity Demanded / % change in Income

  • Positive (+): Normal Good

  • Negative (-): Inferior Good

• Cross Price Elasticity of Demand:

  • Formula:

    • % change in Quantity Demanded of Good 1 / % change in Price of Good 2

  • Positive (+): Substitute

  • Negative (-): Complement

Page 9: Qualities of a Good that Determines Elasticity

• Factors:

  • Substitutability

  • Proportion of income spent on the product

  • Time Horizon

  • Definition of Market

  • Luxury vs. Necessity

  • Habit-forming nature

Page 10: Substitutability

• Impact on Elasticity:

  • More substitutes = More elastic

  • Fewer substitutes = More inelastic

Page 12: Proportion of Income Spent on Product

• Influence:

  • Low-priced goods (small income portion) tend to be more inelastic.

  • High-priced goods (large income portion) tend to be more elastic.

  • Wealthier individuals generally have more inelastic demand across products.

Page 14: Time Horizon

• Consumer Response:

  • More time = More elastic

  • Less time = More inelastic

Page 16: Definition of Market

• Market Boundaries:

  • Narrowly defined markets tend to be more elastic.

  • Broadly defined markets tend to be less elastic/inelastic.

Page 18: Luxury vs. Necessity

• Elasticity Comparison:

  • Luxuries: More elastic

  • Necessities: More inelastic

Page 20: Habit-forming Goods

• Characteristics:

  • Goods like cigarettes, alcohol, and drugs have more inelastic demand