Elasticity of Demand

1. Elasticity of Demand

2. What you will learn • Learn what demand schedule is (review) • Learn the law of demand (review) • What elasticity of demand is • Various determinants of the elasticity of demand

3. Demand Schedule for Coffee Beans Price of coffee beans (per pound) Quantity of coffee beans demanded (billions of pounds) $2.00 7.1 7.5 1.75 8.1 1.50 8.9 1.25 10.0 1.00 11.5 0.75 14.2 0.50 Review: The Demand Schedule and the Demand Curve • A demand schedule shows how much of a good or service consumers will want to buy at different prices.

4. Demand curve, D Review:the demand schedule and the demand Curve Price of coffee bean (per gallon) A demand curve is the graphical representation of the demand schedule; it shows how much of a good or service consumers want to buy at any given price. $2.00 1.75 1.50 1.25 1.00 As price rises, the quantity demanded falls 0.75 0.50 0 7 9 11 13 15 17 Quantity of coffee beans (billions of pounds)

5. Law of Demand • The law of demand tells us that when the price goes up, the quantity demanded goes down and vice-versa. • But how much does the quantity demanded change when the price changes?

6. Elasticity of Demand A demand curve is said to be elasticwhen an increase in price reduces the quantity demanded a lot (and vice-versa) When the same increase in price reduces quantity demanded just a little, then the demand curve is said to be inelastic

7. Elasticity of Demand Inelastic Demand Elastic Demand Price Price $50 $50 $40 $40 Quantity Quantity 75 80 20 80 …causes small decrease in quantity demanded …causes big decrease in quantity demanded

8. Elasticity Rule • Elasticity Slope BUT: • If two linear demand (or supply) curves run through a common point, then at any given quantity the curve that is FLATTER IS MORE ELASTIC P D2 D1 Q

9. Determinants of the Elasticity of Demand • Availability of substitutes*** • Time horizon • Category of product (specific or broad) • Necessities vs. Luxuries • Purchase size *** this is the fundamental determinant.

10. Determinants of the Elasticity of Demand • The availability of substitutes strongly influences the sensitivity of quantity demanded to changes in price • For goods with manysubstitutes, when prices change, switching brands is EASY; so demand is elastic • For goods with fewersubstitutes, consumers find it HARD to adjust quantity demanded much when prices changes; so demand is inelastic

11. Quick Examples • Gasoline • Brazilian Coffee • Insulin • Bayer Aspirin • Inelastic • Elastic • Inelastic • Elastic

12. Determinants of the Elasticity of Demand 2. The time horizon influences the elasticity of demand for a good • Immediately following a price increase, consumers may not be able to alter their consumption patterns (making demand inelastic) • Over time, however, consumers can adjust their behavior by finding substitutes (making demand elastic)

13. Determinants of the Elasticity of Demand 3. The classification of the good influences the elasticity of demand for a good • The broader the classification, the less likely consumers will be to find a substitute (making demand inelastic) • The narrower the classification, the more likely the consumer will be to find substitutes (making demand elastic) • E.g., the demand for “food” (a broad classification) is less elastic than for the demand for “lettuce” (narrow classification)

14. Determinants of the Elasticity of Demand 4. The nature of the good to the consumer can also affect the elasticity of demand • For necessities, consumers do not change quantity demanded much when the price changes (making demand inelastic) • For luxuries, consumers will alter their behavior when the price rises (making demand elastic)

15. Determinants of the Elasticity of Demand 5. The size of the purchase (relative to the consumer’s budget) influences the elasticity of demand • Consumers are less concerned about price changes when the good feels cheap (making demand inelastic) • Consumers become much more concerned about price changes when the good feels expensive (making demand elastic)

16. Determinants of the Elasticity of Demand Summary of Determinants of Elasticity of Demand

17. Test your knowledge • Which of the following two goods is more likely to be inelastically demanded?   • Demand for tangerines • Demand for fruit • After more employers allow employees to telecommute, will the demand curve for cars be more elastic or more inelastic?   • More elastic • More inelastic

18. According to the law of demand, price and quantity demanded are inversely related. • Elasticity of demand is a measure for the change in quantity demanded in response to the change in price. • Elasticity and Slope are NOT the same thing. • Determinants of Elasticity of Demand.