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Elasticity of Demand

Elasticity of Demand. What is elasticity of demand?. Measure of how much quantity demanded respond to changes in price In other words: if the price of a product rises, the consumers will either buy less or the same amount of the product Willingness to buy.

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Elasticity of Demand

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  1. Elasticity of Demand

  2. What is elasticity of demand? • Measure of how much quantity demanded respond to changes in price • In other words: if the price of a product rises, the consumers will either buy less or the same amount of the product • Willingness to buy

  3. What determines elasticity of demand? • Availability of substitutes • Necessities vs. luxuries • Definition of market • Time horizon

  4. Availability of Substitutes • Goods with close substitutes tend to have more elastic demand. • Ex) lemonade and orange juice are substitutes. If the price of lemonade goes up, people will buy more orange juice than lemonade ➔ elastic • Ex) there is no substitute for clocks. Even if price of clock rises, people wil continue to buy clocks ➔ inelastic

  5. Necessities Vs. Luxuries • Necessities tend to have inelastic demands, and luxuries tend to have elastic demands. • Ex) Water is a necessity. Despite the change of price of water, people will still purchase water ➔ inelastic • Ex) a diamond ring is a luxury good. If it is too expensive, people will not buy it ➔ elastic

  6. Definition of Market • Narrowly defined market tend to have elastic demands, and broadly defined market tend to have inelastic demands. • Ex) Car is a broad category. It is inelastic because there are no substitutes. • Ex) Specific brands of car, such as Hyundai and BMW, are narrow category. They are elastic because people will buy cheaper brand of cars.

  7. Time horizon • Longer time horizon tend to have more elastic demand than shorter time horizon. • Ex) When price of gasoline rises for a few months, people will still pay for it ➔ inelastic • Ex) If price of gasoline continues to rise for two years, people will start to use more public transportation or buy fuel-efficient cars ➔ elastic

  8. How to calculate price elasticity of demand? • Price elasticity of demand = % change in quantity demanded / % change in price. • Midpoint method: (Q1-Q2) / {(Q1+Q2)/2}(P1-P2) / {(P1+P2)/2} • Note: the final result of this formula will be a negative number. In this case, ignore the negative sign.

  9. Price Elasticity of Demand Curve

  10. Total Revenue

  11. Income elasticity of demand % change in QD% change in P Cross-price elasticity of demand % change in QD of good 1% change in P of good 2 Other Demand Elasticity

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