Elasticity of Demand

Elasticity of DemandHow sensitive is demand to price changes?

Slope of Demand Curves• Demand curves do not all have the same slope

• Slope indicates response of buyers to a change in price

D1

D1

Price ↑ 10% => Qty Demanded ↓ ? (how much?)

Which demand curve is most sensitive to price changes?

D1

Price

Qty

ELASTICITY OF DEMAND

• Elasticity of demand (Ed) measures the sensitivity of quantity demanded in response to a change in price:

Ed = % change Qty D % change Price

Elastic Demand Curves

• Elastic Demand– Demand is sensitive to price changes

– Demand Curves are flat

– Ed > 1

– A % ↑ Price leads to a greater % decline in Qty Demanded

D1

Px

Qty

Ed = % change Qty D % change Price

Example: Elastic Demand Curve

10% rise in Pricecauses a Greaterthan 10 % decline in Qty D

.

Ed = 1.5 Ed = % change Qty D % change Price

Inelastic Demand Curves

• Inelastic Demand– Demand NOT sensitive to price changes

– Curves are STEEP

– Ed < 1

– A % ↑ Price leads to a SMALLER % decline in Qty Demanded

D1

Px

Qty

Ed = % change Qty D % change Price

Example: Inelastic Demand Curve

Quantity

↑% Price changes Leads to a smaller % decline in Qty D

+100%

-10%

Ed = 0.1

Ed = % change Qty D % change Price

Elasticity depends on:

• Number of close substitutes– more substitutes => more elastic demand

• Whether the good is considered a necessity– Necessities tend to be inelastic, luxury goods are elastic

• Proportion of income spent– larger proportion of income more elastic

• Time period– Longer the time period => the more elastic demand is

Price Elastic or Price Inelastic?

Soda

Heart Surgery Table Salt

Gasoline

Price Inelastic

No real substitutes

Price Inelastic

Necessity &No real substitutes,Short time period

Price Elastic

Many substitutes

Price Inelastic

Small proportionof income, no goodsubstitute

Total Revenue & Profit

• Total Revenue = Price X Quantity

• Profit = Total Revenue - Expenses

Elasticity determines the effect on total revenue

Total Revenue => when Prices elastic goods

Total Revenue => when Prices inelastic goods

Elastic Demand

200 300

$200

$150

Raising prices will lower total revenue!

Elasticity Worksheet

D1

Px

Qty

D1

Px

Qty

Elastic Demand Inelastic Demand

Total Revenue = Price * Quantity

GDP