Do Now 1. Think back to your budget project. What items or services would you cut back on if the price suddenly went up by 50%? 2. How would a raise in.

Do Now

1. Think back to your budget project. What items or services would you cut back on if the price suddenly went up by 50%?

2. How would a raise in price of gas from $3.75/gallon to $4.25/gallon affect your demand for gas if you had to drive yourself to work and school everyday, but could not find someone to share the ride with you?

What factors effect elasticity of demand?

Elasticity of Demand

Elasticity of DemandElasticity of Demand is a measure of how consumers respond to price changesMeasures how drastically buyers will cut back or increase their demand for a good when the price rises or falls

Elastic/InelasticIf you buy the same amount or just a little bit

less of a good after a large price increase, your demand is Inelastic (price changes don’t matter)

If you buy much less of a good after a small price increase, your demand is Elastic (very responsive to price changes)

Factors that Affect Elasticity

1. Availability of Substitutes- If there are few substitutes for a good, then

even when its price rises greatly, you might still buy it – you believe there are no good alternatives: your demand is inelastic

Factors that Affect Elasticity

2. Relative Importance- How much of your budget do you spend on the good? The higher the jump in price, the more you will have to adjust your purchases

Factors that Affect Elasticity3. Necessities v. Luxuries

- a necessity is a good people will always buy, even when the price increases (demand is inelastic)

ex: milk- a luxury can easily be given up (demand is elastic)

ex: steak

Factors that Affect Elasticity

4. Change over Time- Consumers often need time to change their spending habits, because it takes time to find substitutes

ex: gas

Elasticity and RevenueTotal Revenue is the amount of money the company receives by selling its goodsDetermined by 2 factors:

Price of goodsQuantity of goods sold

Total Revenue & Elastic Demand

When a good has an elastic demand, raising the price of each good sold by 20% can decrease the quantity sold by enough to reduce the firm’s total revenue (setting prices too high/low can hurt $$)

Price of a Slice of Pizza Quantity Demanded (per day) Total Revenue

$1.00 300 $300.00

$2.00 250 $500.00

$3.00 200 $600.00

$4.00 150 $600.00

$5.00 100 $500.00

$6.00 50 $300.00

Total Revenue & Inelastic Demand

When demand is inelastic, price and total revenue move in the same directionAn increase in price raises total revenueA decrease in price reduces total revenue

Elasticity and Revenue

As the price is

lowered…

Total revenue

rises

ELASTIC DEMAND

As the price is raised…

Total revenue

falls

INELASTIC DEMAND

As the price is lowered

Total revenue

falls

As the price is raised..

Total revenue rises

Sum it up

INELASTIC DEMAND ELASTIC DEMAND

•Not sensitive to price change•Substitutes not available•Less of income spent on good•Seen as necessity•No time to react in the short term

•Very sensitive to price change•Substitutes available•More of income spent on good•Seen as luxury•Substitutes can be found in the long term

Effect of a Price Change on Quantity Demanded