Elasticity

Elasticity shows how sensitive quantity is

to a change in price.
 THE LAW OF DEMAND SAYS...
Consumers will buy more when prices
go down and less when prices go up
HOW MUCH MORE OR LESS?
DOES IT MATTER?

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 Price Elasticity of Demand (PED)
Price Elasticity of Demand-
• Measurement of consumers
responsiveness to a change in price.
• What will happen if price increase? How
much will it effect Quantity Demanded
Who cares?
• Used by firms to help determine prices
and sales
• Used by the government to decide how to
tax
Inelastic Demand
 Inelastic Demand
INelastic Demand= Quantity is
INsensitive to a change in price.
•If price increases, quantity
demanded will fall a little 20%
•If price decreases, quantity
demanded increases a little.
In other words, people will
continue to buy it.
5%
A INELASTIC demand curve is steep! (looks like an “I”)

Examples:
•Gasoline •Medical Care
•Diapers •Toilet paper
Inelastic Demand
General Characteristics
of INelastic Goods:
•Few Substitutes 20%

•Necessities
•Small portion of
income
5%
•Required now, rather
than later
•Elasticity coefficient
less than 1
Elastic Demand
 Elastic Demand
Elastic Demand = Quantity is
sensitive to a change in price.
•If price increases, quantity
demanded will fall a lot
•If price decreases, quantity
demanded increases a lot.
In other words, the amount
people buy is sensitive to price.
An ELASTIC demand curve is flat!
Examples:
•Soda •Real Estate
•Boats •Pizza
•Beef •Gold
Elastic Demand
General Characteristics
of Elastic Goods:
• Many Substitutes
• Luxuries
• Large portion of
income
• Plenty of time to
decide
• Elasticity coefficient
greater than 1
 Elastic or Inelastic?
Beef- Elastic- 1.27 What about the
Gasoline- INelastic - .20 demand for insulin for
Real Estate- Elastic- 1.60 diabetics?
Medical Care- INelastic - .31 What if % change in
Electricity- INelastic - .13 quantity demanded equals
Gold- Elastic - 2.6 % change in price?
Perfectly Unit Elastic (Coefficient =1)
Ineleastic
 REVIEW: Inelastic Demand
INelastic Demand= Quantity is
INsensitive to a change in price.

•If price increases, quantity

20%
demanded will fall a little
•If price decreases, quantity
demanded increases a little.
In other words, people will
continue to buy it. 5%

A INELASTIC demand curve is steep! (looks like an “I”)

Examples: Gasoline, Medical Care
 REVIEW: Elastic Demand
Elastic Demand = Quantity is
sensitive to a change in price.
•If price increases, quantity
demanded will fall a lot
•If price decreases, quantity
demanded increases a lot.
In other words, the amount
people buy is sensitive to price.

An ELASTIC demand curve is flat!

Examples: Soda, Beef
 Elasticity Visualized

D
D
D D
D D
Perfectly Relatively Unit Relatively Perfectly
Inelastic Inelastic Elastic Elastic Elastic

Elasticity Elasticity Elasticity Elasticity Elasticity

Coefficient Coefficient Coefficient Coefficient Coefficient

0 <1 1 >1 ∞
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 Related Video
• Paul Solman Elasticity video

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 Total Revenue (P x Q)
Relatively Inelastic Relatively Elastic

S1 S1
S S

D
D

1. What happens to quantity for each when

price increases?
2. What happens to total revenue for each
when price increases? 15
 Total Revenue (P x Q)
Relatively Inelastic Relatively Elastic

S1 S1
S S

D
D

1. What happens to quantity for each when price

increases? Quantity for each will decrease
2. What happens to total revenue for each when
price increases?TR for inelastic good will increase
TR for elastic good will decrease 16
 Total Revenue Test
Uses elasticity to show how 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
A Price decreased and TR increased,
so…
50% Demand is ELASTIC
B

125%
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Price Decreased (from $10 to $9)
Total Revenue Increased (from $250 to $270)
Elastic
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 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
 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 a… 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%…
2008 Audit Question 34
 Price Elasticity of Supply
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
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)
 Related Video
• The Oprah Curve

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2010 Question 6

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 Practice Questions
1. 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
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 Practice Questions
1. 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
Normal Good (income elasticity is positive)
Complements (cross price elasticity is negative) 29
 Practice Questions
1. Which of the following must be true for
original Michelangelo sculptures?
A. The demand is relatively elastic
B. The supply is perfectly elastic
C. The demand is perfectly inelastic
D. The supply is perfectly inelastic
E. The demand is perfectly elastic

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

The quantity is SET.

It doesn’t matter if the price
increases or decreases,
the quantity will be the same.
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Workbook
Packet 2-3
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