1. Elasticity And it’s applications

2. Demand • Elasticity is used to measure the level of response for quantity demand or supplied to the price • Price elasticity of Demand measures how much demand responds to price changes • There are 4 determinates of price elasticity of demand

3. Determinates of Price Elasticity of Demand • Availability of close substitutes: the more substitutes available the more elastic (more responsive) it’s demand • Necessities vs. Luxuries: necessities are more inelastic (less responsive) • Definition of market: narrowly defined markets are more elastic than broadly defined ones • Time horizon: goods are more elastic over time

4. Calculating the elasticity • Simple formula • Price Elasticity of Demand = • Using the Midpoint to calculate %age s • Point A: Price = $4 quantity = 120 • Point B: Price = $6 quantity = 80 • (6-4)/5* 100 = 40% • (120-80)/100*100 =40% • 40/40 =1 • Elasticity = 1 % age in quantity demanded %age in price

5. Elasticity classification • Price elasticity of demand is greater than 1 then demand is elastic • Price elasticity of Demand is less than 1 demand is inelastic • Price elasticity of Demand = 1 demand is unit elastic • The flatter the demand curve the more elastic the demand

6. Demand $5 4 1. An increase in price . . . 100 2. . . . leaves the quantity demanded unchanged. Figure 1 The Price Elasticity of Demand (a) Perfectly Inelastic Demand: Elasticity Equals 0 Price Quantity 0

7. 1. At any price above $4, quantity demanded is zero. $4 Demand 2. At exactly $4, consumers will buy any quantity. 3. At a price below $4, quantity demanded is infinite. Figure 1 The Price Elasticity of Demand (e) Perfectly Elastic Demand: Elasticity Equals Infinity Price Quantity 0

8. $5 4 1. A 22% Demand increase in price . . . 90 100 2. . . . leads to an 11% decrease in quantity demanded. Figure 1 The Price Elasticity of Demand (b) Inelastic Demand: Elasticity Is Less Than 1 Price Quantity 0

9. $5 4 Demand 1. A 22% increase in price . . . 80 100 2. . . . leads to a 22% decrease in quantity demanded. Figure 1 The Price Elasticity of Demand (c) Unit Elastic Demand: Elasticity Equals 1 Price Quantity 0

10. Elasticity and revenue • When demand is inelastic price and total revenue move in the same direction • When demand is elastic price and total revenue move in opposite directions • When demand is unit elastic revenue remains constant with price changes

11. Other Demand Elasticities • Income Elasticity • Types of Goods • Normal Goods • Inferior Goods • Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods.

12. Other Demand Elasticities • Income Elasticity • Goods consumers regard as necessities tend to be income inelastic • Examples include food, fuel, clothing, utilities, and medical services. • Goods consumers regard as luxuries tend to be income elastic. • Examples include sports cars, furs, and expensive foods.

13. Place these items in order from most elastic to least elastic • Beef • Salt • European Vacation • Steak • Honda Accord • Dijon Mustard