(Price) Elasticity of Demand

What is elasticity? What are the types of elastic demand?

How do you graph the types of elasticity?How do you calculate elasticity?

Why do businesses care about elasticity of demand?

What is elasticity?

• Elasticity is the degree to which a quantity demanded (or quantity supplied) changes in response to a change in price– In other words: how

strongly consumers (or suppliers) react to a change in price

– Will the reaction be large (stretched band), small (very little stretch) or none at all?

• We calculate elasticity with the following equation:

Calculating Elasticity

• What does this equation mean?

• “the % change in quantity demanded (Qd), divided by the % change in price”

• How do you calculate a percentage change?

Original # - New # x 100 original #

• Another important thing to remember is that percentage changes can be positive or negative, but elasticity is always an absolute value (positive).

A few other quick notes…

• Elasticity can be roughly compared by looking at the relative steepness or flatness of a curve.

• It makes sense that the formula for calculating elasticity is similar to the formula used for calculating slope (rise/run)=(quantity/price).

• Remember to drop any minus signs when finding your final value for elasticity.

Stop and Practice…

AMC movie theater sells 400 bags of Sour Patch Kids for $4.25. However, due to a new kids’ movie, they decide to sell the bags for $4.05—selling 500 bags. What is the elasticity of demand?

• Step 1: calculate the percentage change of quantity demanded

(400-500) = (-0.25)=-25%(400)

• Step 2: calculate the percentage change of price

(4.25-4.05) = (0.05)=5%(4.25)

• Step 3: Make the numbers positive, then solve using the equation

(.25) = 5 (.05)

The elasticity is equal to 5.• We’ll discuss what this means in

just a bit…

Graphing elasticity

• Graphically, elasticity can be represented by the appearance of the demand (or supply) curve.

• If a curve is more elastic, then small changes in price will cause large changes in quantity consumed. – This curve will be close to

horizontal

Graphing elasticity

• If a curve is less elastic (inelastic), then it will take large changes in price to effect a change in quantity consumed. – This curve will tilt more

vertically

• At the extremes, a perfectly elastic curve will be horizontal– An Elastic curve is

flatter, like the horizontal lines in the letter E.

• a perfectly inelastic curve will be vertical.– an Inelastic curve is

more vertical, like the letter I.

• Remember elasticity of demand is the degree of reaction in demand quantity with respect to price.

• Consider a case where demand is very elastic, that is, when the curve is almost flat.

• You can see that if the price changes from $0.75 to $1 (increases), the quantity demanded decreases by a lot.

• There are many possible reasons for this phenomenon; Buyers:– might be able to easily

substitute, so price increases, demand decreases

– Might not want the good that much, so a small change in price will keep them away completely

• If demand is very inelastic, then large changes in price won't do very much to the quantity demanded.

• In the inelastic curve, a price jump of a full dollar reduces the demand by just 2 units.

• It takes a very big jump in price to change how much demand there is in the graph.

• Possible explanations for this situation:– the good is an essential good

that is not easily substituted – consumers really want or

really need the good—they will need to buy the same amount of the good from week to week, regardless of the price.

What kinds of elasticity exist?

1. Elastic—when the % change in Qd (numerator) is greater than % change in P (denominator)– VALUE IS

THEREFORE GREATER THAN ONE (1)

2. Inelastic—when the % change in Qd (numerator) is less than % change in P (denominator)– VALUE IS

THEREFORE LESS THAN ONE (1)

3. Unit(ary) elastic—when the % change in Qd (numerator) is equal to the % change in P (denominator)– VALUE IS

THEREFORE EQUAL TO ONE (1)

– Dividing point between elastic and inelastic demand (where total revenue is maximum)

What kind of elasticity existed in our example problem?

AMC movie theater sells 400 bags of Sour Patch Kids for $4.25. However, due to a new kids’ movie, they decide to sell the bags for $4.05—selling 500 bags. What is the elasticity of demand?

The elasticity is equal to 5.

So, we have a high elastic demand.

Let’s practice!