U2 M46 Elasticity

Price Elasticity of Demand

• Measurement of consumers responsiveness to a change in price.

• What will happen if the price increases? How much will it affect Quantity Demanded?

Usages

• Used by firms to help determine prices and sales

• Used by the government to decide how to tax

Inelastic Demand - Quantity is insensitive to a change in price

• If price increases, quantity demanded will fall a little

• If price decreases, quantity demanded increase a little

• Ex. medicine, Gas, toilet paper

• Characteristics

  • few substitutes

  • necessities

  • small portion of income

  • required now, rather than later

  • elasticity coefficient less than 1(steep curve)

Elastic Demand: Quantity is sensitive to a change in price

• If price increases, quantity demanded will decrease a lot

• If price decreases, quantity demanded will increase a lot

• Ex. Real Estate

• Characteristics

  • many substitutes

  • luxuries

  • large portion of income

  • plenty of time to decide

  • elasticity coefficient greater than 1 (Elastic Demand curve is Flat)

  

Elasticity and Effect on Total Revenue

• Total Revenue = Price * Quantity

• 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