ELASTICITY OF DEMAND Chapter 4 section 2. IF THERE’S A 50% INCREASE IN PRICE OF 1. Salt 2. 2015 Nissan GTR 3. Pork chops 4. Insulin (you’re diabetic)

ELASTICITY OF DEMANDChapter 4 section 2

IF THERE’S A 50% INCREASE IN PRICE OF

1. Salt

2. 2015 Nissan GTR

3. Pork chops

4. Insulin (you’re diabetic)

5. Gas one day after price increase

6. Gas one year after price increase

Would you still buy it? Why?

WHAT FOUR FACTORS DETERMINE ELASTICITY OF DEMAND?

1. Number of substitutes

2. Luxuries versus necessities

3. Percentage of income spent on the good

4. Time to adjust to the price change

WHAT IS ELASTICITY OF DEMAND? Elasticity of demand dictates how drastically buyers will cut back when a price rises or increase their demand for a good when the price falls

Elasticity of = % change in quantity demanded

Demand % change in priceP

QQ1

P1

Q2

P2

D

HOW IS ELASTICITY OF DEMAND MEASURED? If the demand is very sensitive

to a change in price it is

elastic If the demand is not very

sensitive to a change in price it is inelastic

DP

Q

D

P

Q

P1

Q1 Q2

P2

1. NUMBER OF SUBSTITUTES

A product with lots of substitutes tends to be elastic

A product with few or no substitutes tends to be inelastic

P

QQ1

P1

Q2

P2

D

AVAILABILITY OF SUBSTITUTES CONT.

If your favorite musical group has a concert and you want to attend, there really is no substitute for a ticket

If a moderate change in price does not change your mind, is demand elastic or inelastic?

Inelastic

DP

Q

2. LUXURIES VERSUS NECESSITIES

Do you need it to survive? Heart medicine tends to be inelastic Coach purses tend to be elastic

3. PERCENT OF INCOMESPENT ON THE GOOD

How expensive is it? Buyers are more responsive to

price changes for goods on which they spend a larger percentage of their incomeP

QQ1

P1

Q2

P2 D

PERCENTAGE OF INCOME SPENT ON THE GOOD CONT. Buyers are less

responsive to price changes for goods on which they spend a small percentage of their income If the price of chewing

gum doubled, would you cut back on buying gum?

Your demand for gum is inelastic D

P

QQ1

P1

Q2

P2

4. TIME TO RESPOND PRICE CHANGE

Because consumers cannot respond quickly to price changes, their demand is inelastic in the short term

When a price changes, consumers often need time to change their shopping habits or find a substitute. Demand is elastic in the long run.

4. TIME TO RESPOND PRICE CHANGE CONT.

WHY IS ELASTICITY IMPORTANT?

It tells business owners if raising their prices will result in a bigger total revenue

Or

A smaller total revenue

Total revenue = price of goods X quantity sold

PRICE, ELASTICITY, AND TOTAL REVENUE In July Joe’s Pizza sells pizza for

$2.50 a slice and sells 200 slices per day.

In August Joe raises his prices from $2.50 to $3 per slice, then the amount he sells would decrease from 200 to 100 slices a day.

Increase in Price resulted in an Decrease in Total Revenue! Joe’s pizza is ELASTIC

Price Quantity sold

Total Revenue

July 2.50 200 $500

August 3.00 100 $300

If Price INcreases and Total Revenue DEcreases, then the good is…

Elastic Inelastic Unit-elasticfor demand

PRICE, ELASTICITY, AND TOTAL REVENUE

John’s Pizza in Barrow, Alaska, also sells his pizza for $2.50 a slice and sells 200 slices a day.

If John raised his prices from $2.50 to $3 per slice, then the amount he sold would decrease from 200 to 175 slices a day.

Increase in Price resulted in an INcrease in Total Revenue! John’s Pizza is relatively INELASTIC for demand

Price Quantity sold

Total Revenue

July 2.50 200 $500

August 3.00 175 $525

If price INcreases and Total Revenue INcreases, then the good is…

Elastic Inelastic Unit-Elasticfor demand

MOVIES TEND TO BE UNIT-ELASTIC

Unit-elastic means the % they increase the price is exactly equal to the % demand drops

Price Quantity sold

% change Qd% change price

Total Revenue

July 10 200 2000

August 20 100 2000

If price INcreases and Total Revenue Stays the Same, then the good is…

Elastic Inelastic Unit-Elasticfor demand

Students complete Activity 2 with a partner Get out ONE piece of paper—2

people, 1 paper

DO NOT WRITE ON ACTIVITY 2!

Price Total Revenue Elasticity of Demand

↑ ↓ Elastic

↓ ↑ Elastic

↑ ↑ Inelastic

↓ ↓ Inelastic

↑ or ↓ ═ Unit-elastic