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Elasticity
Elasticity shows how sensitive quantity is
to a change in price.
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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
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Inelastic Demand
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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
•Milk
•Diapers
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•Chewing Gum
•Medical Care
•Toilet paper
Inelastic Demand
General Characteristics
of INelastic Goods:
20%
•Few Substitutes
•Necessities
•Small portion of
income
•Required now, rather
than later
•Elasticity coefficient
less than 1
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5%
Elastic Demand
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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
•Boats
•Beef
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•Real Estate
•Pizza
•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
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Elastic or Inelastic?
BeefGasolineReal EstateMedical CareElectricityGold-
What about the
Elastic- 1.27
demand for insulin for
INelastic - .20
diabetics?
Elastic- 1.60
INelastic - .31
What if % change in
INelastic - .13 quantity demanded equals
% change in price?
Elastic - 2.6
Perfectly INELASTIC
(Coefficient = 0)
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Unit Elastic (Coefficient =1)
Elasticity Visualized
D
D
D
D
D
D
Perfectly
Inelastic
Relatively
Inelastic
Unit
Elastic
Relatively
Elastic
Perfectly
Elastic
Elasticity
Coefficient
Elasticity
Coefficient
Elasticity
Coefficient
Elasticity
Coefficient
Elasticity
Coefficient
0
<1
1
>1
∞
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Total Revenue (P x Q)
Relatively Inelastic
S1
S
Relatively Elastic
S1
S
D
1. What happens to quantity for each when
price increases?
2. What happens to total revenue for each
when price increases?
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D
12
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
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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
50%
B
125%
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Price decreased and TR increased,
so…
Demand is 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
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2008 udit Question 34
2010 Question 6
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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%…
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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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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)
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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
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