What is Elasticity of Demand? Elasticity of demand is a measure of how consumers react to a change in price

Elasticity of Demand Demand for a good that is very sensitive to changes in price is elastic (example: you buy much less of something after a small price increase) Demand for a good that is not very sensitive to a change in price (example: consumers continue to buy it despite an increase in price) is inelastic

Calculating Elasticity of Demand Elasticity is determined using the following formula: % Change in Quantity Demanded / % Change in Price % Change = (Original # - New # / Original #) X 100 (Ignore any negative signs)

Varies at Every Price Level The elasticity of demand for a good varies at every price level (can be highly elastic at one price and inelastic at a different price) Example: the demand for a magazine is inelastic when the price rises from 20 cents to 30 cents because the price is still very low & people will buy almost as many copies of the magazine as they did before

Values of Elasticity If the elasticity of demand for a good at a certain price is less than 1, we describe the demand for the good as inelastic If the elasticity is greater than 1, demand is elastic If the elasticity is exactly equal to 1, demand is unitary elastic (% change in quantity demanded = % change in price)

Factors Affecting Elasticity Why is the demand for some goods so much less elastic than for other goods? In other words, people think about what is essential to them and what goods they must have even if the price rises greatly Several different factors can affect a person’s elasticity of demand for a specific good

Availability of Substitutes A lack of substitutes makes demand inelastic (example: you would continue to buy medicine, even when the price increased, until you could not afford it anymore A wide choice of substitutes makes demand elastic (example: deciding between a particular brand of apple juice)

Relative Importance How much if your budget you spend on a good If you spend a large amount of your income on a good, even a modest price increase will greatly affect you because you must reduce consumption of that good by a significant amount to keep your budget under control (demand is elastic) Ex: If you spent half your $ on clothes

Relative Importance If a good accounts for a tiny part of your overall budget, your demand for it will be inelastic Example: If the price of shoelaces doubled (you might not even notice the difference because shoelaces are a very small part of your entire budget)

Necessities Versus Luxuries Whether a person considers a good to be a necessity (a good he or she will always buy, even when the price increases) or a luxury (can easily reduce the quantity consumed if the price increases) has a great impact on the good’s elasticity of demand for that person This factor obviously varies a great deal from person to person

Necessities Versus Luxuries Examples: Parents often regard milk as a necessity because they will buy it at any reasonable price to try to keep their children healthy; their demand for milk is inelastic These same parents may feel that steak is a luxury because they could skip buying it if the price increased; their demand for steak is elastic

Change over Time When a price changes, consumers often need time to change their shopping habits. Consumers do not always react quickly to a price increase because it takes time to find substitutes. If consumers cannot respond quickly to price changes, their demand is inelastic in the short term and becomes more elastic over time because they can eventually find substitutes that allow large adjustments to what they buy.

Change over Time Example: gasoline prices have stayed high Many people have found substitutes over time (switched to more fuel efficient cars like hybrids or rode bicycles, joined carpools, or walked); demand for gas is inelastic in the short term and more elastic in the long term Drivers who travel large distances are more likely to change how they consume gasoline (demand is more elastic for them compared to someone who lives very close to their family, where they work, etc.)

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 $ it receives from selling its good or services Firms need to be aware of the elasticity of demand for the good or service they are providing If a good has an elastic demand, raising prices may decrease the firm’s total revenue

Elasticity and Revenue Remember that elastic demand comes from one or more of these factors: Availability of substitute goods A limited budget that does not allow price changes The perception of the good as a luxury If these conditions are present, a business could lose $ if it raises prices (ex. if a pizzeria tried to sell pizza at $10 a slice)