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Elasticity of Demand ■ ■ ■ ■ Are there goods that you would buy, even if the price were to rise drastically? Are there goods that you would cut back on, or quit buying if the price rose? Elasticity of Demand- a measure of how consumers react to a change in price http://www.youtube.com/watch?v=VhKI8cOaYLI Elasticity of Demand Cont’d ■ ■ ■ ■ The demand for the good that you will keep buying despite the price increase is inelastic Inelastic- describes the demand that is not very sensitive to change in price If you buy much less of a product after a price increase this is elastic Elastic describes demand that is very sensitive to a change in price Calculating Elasticity To compute elasticity of demand: ■ Take the % change in the demand of the good ■ Divide this number by the % of change in the price of the good Note: The law of demand implies that the result will always be negative. This is because an increase of price=decrease in demand and decrease in price=increase the quantity demanded ■ A Better View Price Range ■ ■ ■ ■ The elasticity of demand for a good varies at every level Price of baked potato increases 50% from $1.00 to $1.50=price is still pretty low (people will buy about the same number) Price baked potato increases 50% from $10.00 to $15.00=many spud lover will refuse to pay $15 for a baked potato Differs even though the % increase was the same Values of Elasticity ■ ■ ■ Elastic & Inelastic have precise mathematical definitions Unit elastic- describes the demand whose elasticity is exactly equal to 1 When elasticity of demand is unitary, the % of change in demand is exactly equal to the % change in price Example of Unit Elastic ■ ■ Suppose the elasticity of demand for a $2 magazine at Bill’s newsstand is unitary When the price of the magazine rises by 50% to $3, Bill will sell exactly half as many copies as before Example of Inelastic ■ ■ ■ ■ ■ Ron’s demand for my baked potatoes at $1 is 4 potatoes per day If the price increases 50% to $1.50 the demand decreases to 3 potatoes per day 25% percent decrease in demand divided by the 50% increase gives us an elasticity demand of 0.5 Ron’s elasticity of demand is less than one=inelastic The price increase has a relatively small effect on the number of potatoes he buys Example of Elastic ■ ■ ■ ■ ■ Suppose Esteban raises the price in his gypsy jewelry from $1 to $1.50 Demand falls from 10 bracelets to 4 bracelets because of price increase Change in price=50% Change in demand for product=60% Demand is elastic since the elasticity of demand is greater than 1 Availability of Substitutes ■ ■ ■ If there are few substitutes for a good, then even when its price rises greatly, you might still buy it Example: prescription drugs=inelastic Concert tickets=elastic Relative Importance ■ ■ A second factor in determining a good’s elasticity is how much of your budget you spend on the good If you spend a large amount of your income on the good and the price goes up, you have some tough choices to make Necessities Versus Luxuries ■ ■ ■ The third factor in determining a good’s elasticity varies a great deal from person to person, but it is nonetheless important. Whether a person considers a good to be a necessity or a luxury has a great impact on the good’s elasticity of demand for that person Example: The Rock and his gym membership Change Over Time ■ ■ ■ Demand is more inelastic in the short term Demand is more elastic over a long period of time Demand for gasoline, inelastic in the short term, is more elastic in the long term Elasticity and Revenue ■ ■ Total revenue- the total amount of money a firm receives by selling goods or services If a pizzeria sells 125 slices of pizza per day ay $2 per slice, total revenue would be $250 per day Elasticity and Revenue Questions?