Elasticity shows how sensitive quantity is to a

Elasticity shows how sensitive quantity is to a change in price. Copyrighted. Revised and used with permission from ACDC Leadership. NOT to be used or shared without express permission from ACDC.

THE LAW OF DEMAND SAYS. . . Consumers will buy more when prices go down and less when prices go up How much more or less will be purchased is a measure of ELASTICITY. 2 Copyright ACDC Leadership 2015

Price Elasticity of Demand (PED) • Measurement of consumers’ responsiveness to a change in price. • What will happen if price increases? • How much will it effect Quantity Demanded? Who uses this information? • Firms - to help determine prices and sales • Government - to decide how to tax

Inelastic Demand

Inelastic Demand INelastic Demand= Quantity is INsensitive to a change in 20% price. ü If price increases, quantity demanded will fall a little 5% ü If price decreases, quantity demanded increases a little. In other words, people will continue to buy it. INELASTIC demand curve is steep! (looks like an “I”) Examples: chewing gum, medical care, toilet paper, gasoline, milk, diapers

Characteristics of Inelastic Demand - SIN • Few Substitutes • Small portion of Income • Necessity versus luxury • Required now, rather than later • Elasticity coefficient less than 1 Copyright ACDC Leadership 2015 20% 5%

Elastic Demand Copyright ACDC Leadership 2015

Elastic Demand = Quantity is sensitive to a change in price. ü If price increases, quantity demanded will fall a lot ü If price decreases, quantity demanded increases a lot. In other words, the amount people buy is sensitive to price. ELASTIC demand curve is flat! Examples: real estate, pizza, gold, soda, boats, beef

Characteristics of Elastic Demand • Many Substitutes • Luxuries • Large portion of income • Plenty of time to decide • Elasticity coefficient greater than 1

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 What about the demand for insulin for diabetics? What if % change in quantity demanded equals % change in price? Perfectly INELASTIC (Coefficient = 0) Unit Elastic (Coefficient =1) Copyright ACDC Leadership 2015

Elasticity Visualized D D D Perfectly Inelastic Relatively Inelastic Unit Elasticity Coefficien t 0 t <1 t 1 Relatively Elasticity Coefficien t >1 11 Copyright ACDC Leadership 2015 Perfectly Elastic t ∞

Total Revenue (P x Q) Relatively Inelastic S 1 S Relatively Elastic S 1 S D 1. What happens to quantity for each when price increases? 2. What happens to total revenue for 12 each when price increases? Copyright ACDC Leadership 2015 D

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

Is the range between A and B, elastic, inelastic, or unit elastic? 10 x 100 =$1000 Total Revenue 5 x 225 =$1125 Total Revenue Price decreased and TR increased, so… Demand is ELASTIC A 50% B 125% Copyright ACDC Leadership 2015

15 Copyright ACDC Leadership 2015

Other Types of Elasticity Cross-Price Elasticity of Demand Income Elasticity of Demand Price Elasticity of Supply

Cross-Price Elasticity of Demand Cross-Price elasticity of demand shows how sensitive a product is to a change in price of another good It shows if two goods are substitutes or complements % change in quantity of product “b” % change in price of product “a” P increases 20% Q increases 40% Q decreases 40% • If coefficient is positive (shows direct relationship) then the goods are substitutes • If coefficient is negative (shows inverse relationship) then the goods are complements Copyright ACDC Leadership 2015

2008 Audit Question 34

2010 Question 6 19 Copyright ACDC Leadership 2015

Income-Elasticity of Demand Income elasticity of demand shows how sensitive a product is to a change in INCOME It shows if goods are normal or inferior % change in quantity % change in income Income increases 20%, and quantity decreases 15% then the good is an… INFERIOR GOOD • If coefficient is positive (shows direct relationship) then the good is normal • If coefficient is negative (shows inverse relationship) then the good is inferior Ex: If income falls 10% and quantity falls 20%…

Practice Questions If the cross price elasticity coefficient of goods A and B is -5 and the income elasticity of good A is 2, which of the following is true? A. A decrease in the price of good A will decrease the demand for good B B. An increase in income will decrease the demand for good A C. Goods A and B are substitutes D. Good B is an inferior good E. An increase in the price of A will decrease the demand for good B 21 Copyright ACDC Leadership 2015

Price Elasticity of Supply • Elasticity of supply shows how sensitive producers are to a change in price. • Elasticity of supply is based on time limitations. Producers need time to produce more. INelastic = Insensitive to a change in price (Steep curve) - Most goods have INelastic supply in the short-run - Why? Elastic = Sensitive to a change in price (Flat curve) - Most goods have elastic supply in the long-run Perfectly Inelastic Supply= Q doesn’t change Set quantity supplied (Vertical line)

Practice Questions Which of the following must be true for original Michelangelo sculptures? A. B. C. D. E. The The The demand is relatively elastic supply is perfectly elastic demand is perfectly inelastic supply is perfectly inelastic demand is perfectly elastic 23 Copyright ACDC Leadership 2015