Price Elasticity of Demand: Lesson objectives

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Price Elasticity of Demand Lesson objectives

• Explain why elasticity is a measure of
  responsiveness.
• Analyze the elasticity of a product using the
  common sense test, total revenue test and
  elasticity coefficient.
• Understand the factors that determine demand
  elasticity
• Understand using the total revenue test and
  elasticity coefficient that a demand curve with a
  constant slope does not have constant elasticity.

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Elasticity of Demand

• -The change of quantity demand relative to the
  change in price.
• -The responsiveness of quantity demanded to a
  change in price.

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Elasticity of Demand!! Who Cares?

• Why is it important that firms understand the
  concept of elasticity of demand?
• Why is it important that governments understand
  the concept of elasticity of demand?

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Different Elasticities
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Three Tests for Elasticity

• Common Sense Test
• Total Expenditure/Total Revenue Test
• Elasticity Coefficient Test

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Common Sense Test

• Is it a necessity?
• Are there poor Substitutes?
• Do you need it now?
• Does it take a small portion of your income?

• New Car
• Pork chops
• European Vacation
• Coffee
• Insulin
• Insulin at one of four drugs stores in a shopping
  mall.

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Total Revenue/Expenditure Test
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The Elasticity Coefficient
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The Midpoint Formula(Because of the negative
nature of the demand curve, we can use all
absolute values.)
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If Ed gt 1

• Demand is price Elastic
• The change is quantity is greater that the
  Change in price

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If Ed 1

• Demand is Unit Elastic
• The change in quantity is equal to the change
  in price.

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If Ed lt 1

• Demand is price inelastic
• The change in quantity is less than the
  change in price.
• Or.. The change in price is greater than the
  change in quantity.

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Ed 0

• Demand is Perfectly inelastic
• A change in price creates no change in quantity.

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Other Elasticities

• Income Elasticity of Demand
• Cross Elasticity of Demand
• Elasticity of Supply

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Income Elasticity of Demand(Keep all signs!!)

• The Relationship between the change in quantity
  demanded of a good and the change in income.
• If ed is negative then the good is inferior.
• If ed is positive then the good is normal.

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Cross Elasticity of Demand(Keep all Signs!!)

• The relationship between and change in price of
  one good and the change in quantity demanded of
  another.
• If cross elasticity of demand is negative the two
  goods are complements.
• ?QdX is negative positive ? PY is positive
  negative
• If cross elasticity of demand is positive the two
  goods are substitutes.
• ?QdX is positive negative ? PY is positive
  negative

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Elasticity of Supply(Because of the positive
relationship of the supply curve, all values are
absolute.)

• Same rules apply as with price ed.
• Supply elasticity depends largely upon the
  response of inputs to a change in price.
• The quicker inputs can produce more are greater
  quantity of output as price increases, the more
  elastic the supply curve will be.