Download Elasticity of Demand

(Price) Elasticity of Demand
What is elasticity?
What are the types of elastic demand?
How do you graph the types of elasticity?
How do you calculate elasticity?
Why do businesses care about elasticity of
demand?
What is elasticity?
• Elasticity is the degree
to which a quantity
demanded (or quantity
supplied) changes in
response to a change in
price
– In other words: how
strongly consumers (or
suppliers) react to a
change in price
– Will the reaction be large
(stretched band), small
(very little stretch) or none
at all?
• We calculate elasticity
with the following
equation:
Calculating Elasticity
• What does this equation
mean?
• How do you calculate a
percentage change?
Original # - New # x 100
original #
• “the % change in quantity
demanded (Qd), divided
by the % change in price”
• Another important thing to
remember is that
percentage changes can
be positive or negative,
but elasticity is always
an absolute value
(positive).
A few other quick notes…
• Elasticity can be roughly
compared by looking at
the relative steepness or
flatness of a curve.
• It makes sense that the
formula for calculating
elasticity is similar to the
formula used for
calculating slope
(rise/run)=(quantity/price).
• Remember to drop any
minus signs when
finding your final value
for elasticity.
Stop and Practice…
AMC movie theater sells
400 bags of Sour Patch
Kids for $4.25. However,
due to a new kids’ movie,
they decide to sell the
bags for $4.05—selling
500 bags. What is the
elasticity of demand?
•
Step 1: calculate the percentage
change of quantity demanded
(400-500) = (-0.25)=-25%
(400)
•
Step 2: calculate the percentage
change of price
(4.25-4.05) = (0.05)=5%
(4.25)
•
Step 3: Make the numbers
positive, then solve using the
equation
(.25) = 5
(.05)
•
The elasticity is equal to 5.
We’ll discuss what this means in
just a bit…
Graphing elasticity
• Graphically, elasticity can
be represented by the
appearance of the
demand (or supply)
curve.
• If a curve is more elastic,
then small changes in
price will cause large
changes in quantity
consumed.
– This curve will be close to
horizontal
Graphing elasticity
• If a curve is less
elastic (inelastic),
then it will take large
changes in price to
effect a change in
quantity consumed.
– This curve will tilt more
vertically
• At the extremes, a
perfectly elastic curve
will be horizontal
– An Elastic curve is
flatter, like the
horizontal lines in the
letter E.
• a perfectly inelastic
curve will be vertical.
– an Inelastic curve is
more vertical, like the
letter I.
• Remember elasticity of
demand is the degree of
reaction in demand quantity
with respect to price.
• Consider a case where
demand is very elastic, that is,
when the curve is almost flat.
• You can see that if the price
changes from $0.75 to $1
(increases), the quantity
demanded decreases by a lot.
• There are many possible
reasons for this phenomenon;
Buyers:
– might be able to easily
substitute, so price increases,
demand decreases
– Might not want the good that
much, so a small change in
price will keep them away
completely
• If demand is very inelastic,
then large changes in price
won't do very much to the
quantity demanded.
• In the inelastic curve, a price
jump of a full dollar reduces
the demand by just 2 units.
• It takes a very big jump in price
to change how much demand
there is in the graph.
• Possible explanations for this
situation:
– the good is an essential good
that is not easily substituted
– consumers really want or
really need the good—they will
need to buy the same amount
of the good from week to
week, regardless of the price.
What kinds of elasticity exist?
1. Elastic—when the %
change in Qd
(numerator) is greater
than % change in P
(denominator)
– VALUE IS
THEREFORE
GREATER THAN
ONE (1)
2. Inelastic—when the
% change in Qd
(numerator) is less
than % change in P
(denominator)
– VALUE IS
THEREFORE LESS
THAN ONE (1)
3. Unit(ary) elastic—
when the % change in
Qd (numerator) is
equal to the %
change in P
(denominator)
– VALUE IS
THEREFORE EQUAL
TO ONE (1)
– Dividing point
between elastic and
inelastic demand
(where total revenue
is maximum)
What kind of elasticity
existed in our
example problem?
AMC movie theater sells 400
bags of Sour Patch Kids for
$4.25. However, due to a new
kids’ movie, they decide to sell
the bags for $4.05—selling
500 bags. What is the elasticity
of demand?
The elasticity is equal to 5.
So, we have a high elastic
demand.
Let’s practice!