MORE ON DEMAND…ELASTICITY!

1. You need to bake a cake but have run out of sugar. The last time you bought sugar, it cost you $.79, but now it costs $1.29.

2. You usually buy Granny Smith apples. They used to cost $1.49 per pound, but now they cost $2.00 per pound.

   3. Your grandma needs her insulin (she is a diabetic). It used to cost

$20 per month but now it costs $50 per month.   4. Gas prices increased from $3.79 to $4.79, but your tank is empty

and your friends are counting on you to drive tonight.   5. Gas prices increase from $3.79 to $4.79 over the next few years.

They are expected to stay this high.

6. Your rent payment increases from $700 per month to $1000 per month.

We know the relationship between price and quantity demanded now: P QD and P QD

But just how much will buyers cut back or increase their demand for a good when the price rises or falls Demand for all goods is NOT the same!

Elasticity of demand: describes the way thatconsumers respond to price changes

Used to quantify the response in one variable when another variable changes

We can see this by looking at the SLOPE of thedemand curve (Just how much does quantity change as price changes?)

Elasticity is a ratio of: Percentage change in quantity demanded

Percentage change in price

We will be using the midpoint formula for calculating the percentage changes!

% change = Original number – New number x100

(original + new) / 2

*Absolute value is what matters!

Hypothetical Demand Elasticities of Four Products

PRODUCT % Δ P %Δ Qd ELASTICITY

Insulin +10% 0% 0.0 → Perfectly inelastic

Cell phoneservice

+10% -1% -0.1→ Inelastic

Beef +10% -10% -1.0 → Unitarily elastic

Bananas +10% -30% -3.0 → Elastic

Perfectly inelastic demand – quantity demanded does not respond at all to a change in price◦ you will keep buying even when the price

increases (E = 0)◦ Insulin (As price went up by 10%, quantity

demanded did not change at all! Everyone still bought the same amount.)

Inelastic demand – demand that responds somewhat, but not a great deal, to changes in

price (E < 1)

most people still buy when price increases Telephone service (when price went up 10%,

quantity demanded only changed by 1%) – most people still purchase phone services when the price goes up.

You might cut back a little on how much you use your phone.

Unitarily elasticity – the percentage change in quantity demanded is the same as the percentage change in price (E = 1)

Beef – As price goes up by 10%, quantity demanded decreases by 10% (people buy 10% less beef).

◦ There are substitutes for beef, but people will still buy beef to some extent.

◦ Elastic demand – percentage change in quantity demanded is larger than percentage change in price (E > 1) you buy much less of a good after a small

price increase Bananas – when price went up 10%, people

bought 30% fewer bananas (many substitutes for fruit)

◦ Perfectly elastic demand – quantity demanded drops to zero at the slightest increase in price You buy none of a good after a small price

increase These are hard to find in real life…usually

goods with no brand recognition and MANY, MANY substitutes.

Availability of Substitutes◦ More substitutes = More elastic

Relative Importance◦ More important to you = More inelastic

Necessities versus Luxuries◦ Necessities = Inelastic

Change over Time ◦ More time to adjust = More elastic

Expense (% of your budget/income)◦ Greater % of your income = More elastic

For a company: ↑ P = ↓ Q and vice versa But what happens to their total revenue

(TR)? If they can ↑ P and still sell enough, then TR

will also ↑ TR may rise, fall, or remain the same Price elasticity of demand will tell us

everything we need to know!

Elasticity (Absolute Value)

Demand is Price and TR

Less than 1 Inelastic Change in same directionYou can raise price and make more $You should never lower price

Greater than 1 Elastic Change in opposite directionYou can lower price and make more $You should not raise price

Equals 1 Unit elastic Changes in price have no effect on TR