Download Elasticity of Demand

Do Now – Write Down Your Answers
• Are there some products that you would
continue to buy, even if the price were to
skyrocket?
• Are there other products that you would
cut back on, or stop buying altogether, if
there was a slight increase in price?
• How much of an increase is too much?
Elasticity of Demand
What factors effect elasticity of
demand?
Elasticity of Demand
• Elasticity of Demand is a measure
of how consumers respond to price
changes
– Measures how drastically buyers will cut
back or increase their demand for a
good when the price rises or falls
Elastic/Inelastic
• If you buy the same amount or just a little
bit less of a good after a large price
increase, your demand is Inelastic (price
changes don’t matter)
• If you buy much less of a good after a
small price increase, your demand is
Elastic (very responsive to price changes)
Factors that Affect Elasticity
1. Availability of Substitutes
-
If there are few substitutes for a good, then
even when its price rises greatly, you might
still buy it – you believe there are no good
alternatives: your demand is inelastic
Factors that Affect Elasticity
2. Relative Importance
- How much of your budget do you spend
on the good? The higher the jump in
price, the more you will have to adjust
your purchases
Factors that Affect Elasticity
3. Necessities v. Luxuries
- a necessity is a good people will always
buy, even when the price increases
(demand is inelastic)
ex: milk
- a luxury can easily be given up
(demand is elastic)
ex: steak
Factors that Affect Elasticity
4. Change over Time
- Consumers often need time to change
their spending habits, because it takes
time to find substitutes
ex: gas
Elasticity and Revenue
• Total Revenue is the amount of
money the company receives by
selling its goods
– Determined by 2 factors:
• Price of goods
• Quantity of goods sold
Total Revenue & Elastic Demand
• When a good has an elastic demand, raising the
price of each good sold by 20% can decrease the
quantity sold by enough to reduce the firm’s total
revenue (setting prices too high/low can hurt $$)
Price of a Slice of Pizza
Quantity Demanded (per day)
Total Revenue
$1.00
300
$300.00
$2.00
250
$500.00
$3.00
200
$600.00
$4.00
150
$600.00
$5.00
100
$500.00
$6.00
50
$300.00
Total Revenue & Inelastic Demand
• When demand is inelastic, price and total
revenue move in the same direction
– An increase in price raises total revenue
– A decrease in price reduces total revenue
Elasticity and Revenue
ELASTIC DEMAND
As the
price is
lowered…
Total
revenue
rises
As the
Total
price is
raised… revenue
falls
INELASTIC DEMAND
As the
price is
lowered
Total
revenue
falls
As the
price is
raised..
Total
revenue
rises
Sum it up
Effect of a Price Change on Quantity Demanded
INELASTIC DEMAND
ELASTIC DEMAND
•Not sensitive to price
change
•Substitutes not available
•Less of income spent on
good
•Seen as necessity
•No time to react in the
short term
•Very sensitive to price
change
•Substitutes available
•More of income spent on
good
•Seen as luxury
•Substitutes can be found
in the long term