CHAPTER 4:

DEMANDLESSON 3: ELASTICITY OF DEMAND

3 CASES OF DEMAND ELASTICITY

Consumers react to a change in price by changing the quantity

demanded. This response is known as demand elasticity—the extent to which a change in price causes a change in the quantity

demanded.

3 CASES OF DEMAND ELASTICITY

1) Elastic Demand

Demand is elastic when a change in price causes a relatively larger change in quantity demanded.

Because the percentage change in quantity demanded is relatively

larger than the percentage change in price, demand between

those two points is elastic.

The key is that consumers have options and do not need any one

vegetable urgently.

ELASTIC DEMAND (easy replacements)

3 CASES OF DEMAND ELASTICITY

2) Inelastic Demand

Demand is inelastic when a given change in price causes

a relatively smaller change in quantity demanded.

For example, a change in the price of a cancer drug may not bring

about much change in the quantity purchased if patients need the

medicine and don’t have other options. Even if the price were cut

in half, the quantity demanded might not increase if patients didn’t

need more.

INELASTIC DEMAND (need to have)

3 CASES OF DEMAND ELASTICITY

3) Unit Elastic Demand

Demand is unit elastic when a given change in price causes

a proportional change in quantity demanded.

EQUAL percentage increase in quantity demanded. Examples of

unit elasticity are difficult to find because the demand for most

products is either elastic or inelastic. Unit elasticity is more like a

middle ground that separates the other two categories of price

elasticity of demand: elastic and inelastic.

To summarize, to measure the elasticity of demand, compare the percentage change in the dependent variable—quantity

demanded—to the percentage in the independent variable—

price.

UNIT ELASTIC DEMAND (normal D curve)

THE TOTAL EXPENDITURES TEST

Determining Total Expenditures

We find total expenditures (or total revenue) by multiplying the price

of a product by the quantity demanded for any point along the

demand curve.

Total Expenditures (Revenue) = P x Q

THE TOTAL EXPENDITURES TEST

We could summarize the changes among these relationships in the

following way:

Elastic demand—a change in price and a change in revenue move in opposite directions (more flattened out demand curve)

Unit elastic demand—there is no change in revenue regardless of

the change in price (our normal demand curve)

Inelastic demand—a change in price and a change in revenue

move in the same direction (more vertical of demand curve)

THE TOTAL EXPENDITURES TESTBusiness Sales

Knowledge of demand elasticity is extremely important to most

businesses. Suppose, for example, that you run your own business

and want to do something that will raise your revenues. You could try to stay open longer, or you could try to advertise in order to

increase sales. You might, however, also be tempted to raise the

price of your product in order to increase total revenue from sales.

This might actually work in the case of medical services, because

the demand for this product is generally inelastic. However, what

would happen if you sold a product with elastic demand, such as

burgers? If you raised the price, your total revenue—which is the

same as expenditures by the consumer—would go down instead of

up. That’s exactly what you didn’t want!

Knowing the demand elasticity for a new product will allow a

business to set (or change) the price to maximize total revenues.

DETERMINANTS OF DEMAND

ELASTICITY

Can the Purchase Be Delayed?

Sometimes consumers cannot postpone the purchase of a product.

This tends to make demand inelastic.

For example, people who need to take a medication on a specific

schedule will pay higher prices if they must. The demand for

tobacco products also tends to be inelastic because the product is

addictive. As a result, a sharp increase in price will lower the

quantity purchased by consumers, but not by very much.

DETERMINANTS OF DEMAND

ELASTICITY

DETERMINANTS OF DEMAND

ELASTICITY

Are Adequate Substitutes Available?

If adequate or similar substitutes are available, consumers can

switch back and forth to take advantage of the best price.

However, the fewer the substitutes available for a product, the more

inelastic the demand.

Note that the size of the market is also important. For example, the

demand for gasoline at a particular station tends to be elastic

because consumers can buy gas at another location. If we ask

about the demand for gasoline in general, however, demand is much more inelastic because there are few adequate substitutes

for either.

DETERMINANTS OF DEMAND

ELASTICITY

Does the Purchase Use a Large Portion of Income?

The third factor is the amount of income required for you to make

the purchase. If the amount is large, then demand tends to be

elastic. If the amount of income is small, demand tends to be

inelastic.