Unit 2 – Lesson 2

Elasticity  The term used by economists to describe how consumers react to price changes.  For example, for many products, if the price increases then demand drops.

Quantity demanded in kg. Price per 100 g

 This is the term used to describe the phenomenon of the increase in price does not significantly decrease demand  In other words, people will continue to buy a product regardless of the price fluctuation

Quantity demanded in Litres Price per Litre

 is there a close, cheaper substitute for the product? If the answer is yes then the demand will be elastic (i.e., will decrease as price increases)  is the consumer unwilling or unable to stop buying the product? If consumers can do without the product then the demand will be elastic. A product may be so popular (e.g., latest Harry Potter book) that consumers will buy it at almost any price. Other products, like gasoline, are essential and consumers must buy it regardless of price.

 For producers the elasticity of demand for a product is very important for them to know when they are trying to decide on a price.  If a product has an inelastic demand, like gasoline, then the higher the price, the more money will be made.  For some products a higher price may mean less money if the drop in demand results in more money lost than is gained by the price increase.

 Inelasticity: if a price increase causes total revenue (money being made by the seller) to rise then demand is inelastic.  Elasticity: if a price increase causes total revenue to drop then demand is elastic.  Unitary Elasticity: if a price increase results in no change in total revenue then demand has unitary elasticity.

 When using these definitions it is important to note that the elasticity of demand may change at different price ranges.  For example: the demand for the latest video game console may be inelastic up to a certain price that most consumers can afford or feel is not unreasonable. It is a popular product and most consumers are willing to pay a high price for it.  However, not many people would pay $15,000 for a new video game console. There will be a price threshold past which the demand will become elastic again. This would be a very useful price for the seller to know.

Price per CakeQuantity Demanded in ‘000’s Total Revenue in ‘000’s Elasticity of Demand Elastic from 1.60 to Unitary elasticity from 1.40 to Inelastic from 1.20 to Inelastic from 1.00 to

 The chart shows that from $1.00 to $1.40 the total revenue goes up. Therefore demand is inelastic.  From $1.40 to $1.60 the total revenue stays the same. The drop in demand has offset the increase in price exactly.  Above $1.60 total revenue drops. Therefore demand is elastic.

 Big businesses have marketing departments that may do research to determine the elasticity of demand for their product. For small businesses trial and error using small price changes may be the approach used. Elasticity of demand can apply to labour as well. Highly skilled workers are able to demand higher wages because there is no easy substitute for their skills. Elasticity of demand is an important consideration for the government when deciding excise taxes. The government taxes products with inelastic demand (e.g., gasoline, because the consumer is willing to pay the higher price). The government also taxes items like alcohol and tobacco, where they are not concerned with a drop in demand.