Elasticity of Demand

What is elasticity of demand?  Measure of how much quantity demanded respond to changes in price  In other words: if the price of a product rises, the consumers will either buy less or the same amount of the product  Willingness to buy  Measure of how much quantity demanded respond to changes in price  In other words: if the price of a product rises, the consumers will either buy less or the same amount of the product  Willingness to buy

What determines elasticity of demand?  Availability of substitutes  Necessities vs. luxuries  Definition of market  Time horizon  Availability of substitutes  Necessities vs. luxuries  Definition of market  Time horizon

Availability of Substitutes  Goods with close substitutes tend to have more elastic demand.  Ex) lemonade and orange juice are substitutes. If the price of lemonade goes up, people will buy more orange juice than lemonade ➔ elastic  Ex) there is no substitute for clocks. Even if price of clock rises, people wil continue to buy clocks ➔ inelastic  Goods with close substitutes tend to have more elastic demand.  Ex) lemonade and orange juice are substitutes. If the price of lemonade goes up, people will buy more orange juice than lemonade ➔ elastic  Ex) there is no substitute for clocks. Even if price of clock rises, people wil continue to buy clocks ➔ inelastic

Necessities Vs. Luxuries  Necessities tend to have inelastic demands, and luxuries tend to have elastic demands.  Ex) Water is a necessity. Despite the change of price of water, people will still purchase water ➔ inelastic  Ex) a diamond ring is a luxury good. If it is too expensive, people will not buy it ➔ elastic  Necessities tend to have inelastic demands, and luxuries tend to have elastic demands.  Ex) Water is a necessity. Despite the change of price of water, people will still purchase water ➔ inelastic  Ex) a diamond ring is a luxury good. If it is too expensive, people will not buy it ➔ elastic

Definition of Market  Narrowly defined market tend to have elastic demands, and broadly defined market tend to have inelastic demands.  Ex) Car is a broad category. It is inelastic because there are no substitutes.  Ex) Specific brands of car, such as Hyundai and BMW, are narrow category. They are elastic because people will buy cheaper brand of cars.  Narrowly defined market tend to have elastic demands, and broadly defined market tend to have inelastic demands.  Ex) Car is a broad category. It is inelastic because there are no substitutes.  Ex) Specific brands of car, such as Hyundai and BMW, are narrow category. They are elastic because people will buy cheaper brand of cars.

Time horizon  Longer time horizon tend to have more elastic demand than shorter time horizon.  Ex) When price of gasoline rises for a few months, people will still pay for it ➔ inelastic  Ex) If price of gasoline continues to rise for two years, people will start to use more public transportation or buy fuel- efficient cars ➔ elastic  Longer time horizon tend to have more elastic demand than shorter time horizon.  Ex) When price of gasoline rises for a few months, people will still pay for it ➔ inelastic  Ex) If price of gasoline continues to rise for two years, people will start to use more public transportation or buy fuel- efficient cars ➔ elastic

How to calculate price elasticity of demand?  Price elasticity of demand = % change in quantity demanded / % change in price.  Midpoint method: (Q 1 -Q 2 ) / {(Q 1 +Q 2 )/2} (P 1 -P 2 ) / {(P 1 +P 2 )/2} Note: the final result of this formula will be a negative number. In this case, ignore the negative sign.  Price elasticity of demand = % change in quantity demanded / % change in price.  Midpoint method: (Q 1 -Q 2 ) / {(Q 1 +Q 2 )/2} (P 1 -P 2 ) / {(P 1 +P 2 )/2} Note: the final result of this formula will be a negative number. In this case, ignore the negative sign.

Price Elasticity of Demand Curve

Total Revenue

Other Demand Elasticity  Income elasticity of demand  % change in Q D % change in P  Income elasticity of demand  % change in Q D % change in P  Cross-price elasticity of demand  % change in Q D of good 1 % change in P of good 2  Cross-price elasticity of demand  % change in Q D of good 1 % change in P of good 2