# Section 3: Elasticity of Demand What Is Elasticity of Demand?

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Section 3: Elasticity of Demand What Is Elasticity of Demand?
Elasticity of demand is a measure of how consumers react to a change in price. Demand for a good that consumers will continue to buy despite a price increase is inelastic. Demand for a good that is very sensitive to changes in price is elastic.

Elastic Demand Elastic Demand
If demand is elastic, a small change in price leads to a relatively large change in the quantity demanded. Follow this demand curve from left to right. Price Quantity \$7 \$6 \$5 \$4 \$3 \$2 \$1 Elastic Demand 5 10 15 20 25 30 Demand The price decreases from \$4 to \$3, a decrease of 25 percent. \$4 – \$3 \$4 x 100 = 25 The quantity demanded increases from 10 to 20. This is an increase of 100 percent. 10 – 20 10 x 100 = 100 Elasticity of demand is equal to 4.0. Elasticity is greater than 1, so demand is elastic. In this example, a small decrease in price caused a large increase in the quantity demanded. 100% 25% = 4.0

Inelastic Demand Inelastic Demand
Price Quantity \$7 \$6 \$5 \$4 \$3 \$2 \$1 Inelastic Demand 5 10 15 20 25 30 Demand If demand is inelastic, consumers are not very responsive to changes in price. A decrease in price will lead to only a small change in quantity demanded, or perhaps no change at all. Follow this demand curve from left to right as the price decreases sharply from \$6 to \$2. The price decreases from \$6 to \$2, a decrease of about 67 percent. \$6 – \$2 \$6 x 100 = 67 The quantity demanded increases from 10 to 15, an increase of 50 percent. 10 – 15 10 x 100 = 50 Elasticity of demand is about The elasticity is less than 1, so demand for this good is inelastic. The increase in quantity demanded is small compared to the decrease in price. 50% 67% = 0.75

Factors Affecting Elasticity
1. Availability of Substitutes If there are few substitutes for a good, then demand will not likely decrease as price increases. The opposite is also usually true. 2. Relative Importance Another factor determining elasticity of demand is how much of your budget you spend on the good. 3. Necessities versus Luxuries 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. 4. Change over Time Demand sometimes becomes more elastic over time because people can eventually find substitutes.

Elasticity and Revenue
The elasticity of demand determines how a change in prices will affect a firm’s total revenue or income. A company’s total revenue is the total amount of money the company receives from selling its goods or services. If a good has an elastic demand, raising prices may actually decrease the firm’s total revenue.

Elastic demand Changing a good’s price brings about a substantial, opposite change in the quantity demanded. Description of products: A. not a necessity B.easily available substitutes C.cost of the product is a large percentage of a consumer’s income

Inelastic Demand Changing a good’s price has only a tiny impact on the quantity demanded. Description of products: A. a necessity B. few or no readily available substitutes C. costs a small portion of a consumers’ income

What are some products that might have a perfectly elastic or perfectly inelastic demands?
Total revenue- total income that a business obtains from selling its products

Elasticity of Supply Elasticity of supply is a measure of the way quantity supplied reacts to a change in price. If supply is not very responsive to changes in price, it is considered inelastic. An elastic supply is very sensitive to changes in price.

What Affects Elasticity of Supply?
Time In the short run, a firm cannot easily change its output level, so supply is inelastic. In the long run, firms are more flexible, so supply can become more elastic.

A Firm’s Labor Decisions
Marginal Product of Labor Labor (number of workers) Output (beanbags per hour) Marginal product of labor Business owners have to consider how the number of workers they hire will affect their total production. The marginal product of labor is the change in output from hiring one additional unit of labor, or worker. 1 4 2 10 6 3 17 7 4 23 6 5 28 31 3 7 32 1 8 –1

Labor (number of workers) Marginal Product of labor
Marginal Returns Increasing, Diminishing, and Negative Marginal Returns Labor (number of workers) Marginal Product of labor (beanbags per hour) 8 7 6 5 4 3 2 1 –1 –2 –3 1 2 3 Increasing marginal returns Increasing marginal returns occur when marginal production levels increase with new investment. Diminishing marginal returns occur when marginal production levels decrease with new investment. 4 5 6 7 Diminishing marginal returns Negative marginal returns occur when the marginal product of labor becomes negative. 8 9 Negative marginal returns

Production Costs A fixed cost is a cost that does not change, regardless of how much of a good is produced. Examples: rent and salaries Variable costs are costs that rise or fall depending on how much is produced. Examples: costs of raw materials, some labor costs. The total cost equals fixed costs plus variable costs. The marginal cost is the cost of producing one more unit of a good.

Government Influences on Supply
By raising or lowering the cost of producing goods, the government can encourage or discourage an entrepreneur or industry. Subsidies A subsidy is a government payment that supports a business or market. Subsidies cause the supply of a good to increase. Taxes The government can reduce the supply of some goods by placing an excise tax on them. An excise tax is a tax on the production or sale of a good. Regulation Regulation occurs when the government steps into a market to affect the price, quantity, or quality of a good. Regulation usually raises costs.

Other Factors Influencing Supply
The Global Economy The supply of imported goods and services has an impact on the supply of the same goods and services here. Government import restrictions will cause a decrease in the supply of restricted goods. Future Expectations of Prices Expectations of higher prices will reduce supply now and increase supply later. Expectations of lower prices will have the opposite effect. Number of Suppliers If more firms enter a market, the market supply of the good will rise. If firms leave the market, supply will decrease.

Price Ceilings In some cases the government steps in to control prices. These interventions appear as price ceilings and price floors. A price ceiling is a maximum price that can be legally charged for a good. An example of a price ceiling is rent control, a situation where a government sets a maximum amount that can be charged for rent in an area.

Price Floors One well-known price floor is the minimum wage, which sets a minimum price that an employer can pay a worker for an hour of labor. A price floor is a minimum price, set by the government, that must be paid for a good or service.

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