Elasticity of Demand

Objectives You may wish to call stu-dents’ attention to the objectives in the Section Preview. The objectives arereflected in the main headings of thesection.

Bellringer Ask students to list fiveproducts they could not do without.Then ask them how their lists mightchange if the price of each productdoubled, tripled, or even quadrupled.Explain that in this section they willlearn how economists characterizegoods and services that people can andcannot do without.

Vocabulary Builder Have studentsread the section to learn the meaningof each key term. Then have them addthe terms and either their definitionsor illustrations of their meanings totheir Economics Journals.

Markets and Prices To build understanding ofthe concept of markets and prices, have studentsuse a tree map graphic organizer like the onebelow to explain the factors that determine elas-ticity. Tell students that a tree map shows a maintopic, main ideas or divisions, and supportingdetails.

Section Reading Support Transparencies A tem-plate and the answers for this graphic organizercan be found in Chapter 4, Section 3 of the SectionReading Support Transparency System.

Graphing the Main IdeaB U I L D I NGB U I L D I NG

K E Y CONCE PTSK E Y CONCE PTS

ChaptChapter er 44 •• Section Section 33

Answer to . . . Cartoon Caption Most studentswill say that no one would buylemonade at such a price.

AA re there some goods that you wouldalways find money to buy, even if the

price were to rise drastically? Are thereother goods that you would cut back on, oreven stop buying altogether, if the pricewere to rise just slightly?

Economists describe the way thatconsumers respond to price changes aselasticity of demand. Elasticity of demanddictates how drastically buyers will cutback or increase their demand for a good

when the price rises or falls, respectively.Your demand for a good that you will keepbuying despite a price increase is inelastic,or relatively unresponsive to price changes.In the second example, in which you buymuch less of a good after a small priceincrease, your demand is elastic. Aconsumer with highly elastic demand for agood is very responsive to price changes.

Calculating ElasticityTo compute elasticity of demand, take thepercentage change in the demand of a good,and divide this number by the percentagechange in the price of the good. You canfind the equation for elasticity in Figure 4.7on page 92. The law of demand implies that the result will always be negative. This is because an increase in the price of agood will always decrease the quantitydemanded, and a decrease in the price of agood will always increase the quantitydemanded. For the sake of simplicity, econ-omists drop the negative sign.

Price RangeThe elasticity of demand for a good variesat every price level. Demand for a good canbe highly elastic at one price and inelasticat a different price. For example, demand

elasticity of demanda measure of howconsumers react to achange in price

inelastic describesdemand that is not verysensitive to a change inprice

elastic describesdemand that is verysensitive to a change inprice

Elasticity of Demand

Section FocusElasticity of demand describes howconsumers will react to a change inthe price of a good. Their reactiondepends on the original price of thegood and the way that good is usedby consumers.

ObjectivesAfter studying this section you will be able to:1. Explain how to calculate elasticity of

demand.2. Identify factors that affect elasticity.3. Explain how firms use elasticity and

revenue to make decisions.

Key Termselasticity of demandinelasticelasticunitary elastictotal revenue

Preview

“After taxes, operating expenses andprofits to stockholders, I’m lucky if Isee a nickel of it!”

� Misspelling “lemonade” might not be thisentrepreneur’s only mistake. How many people willbuy lemonade if the price rises to $25.00 a glass?

Lesson PlanTeaching the Main Concepts

1. Focus Elasticity of demand is con-sumers’ degree of willingness to con-tinue to purchase a good or service inview of rising prices.2. Instruct Begin by explaining elastic-ity of demand. Discuss the differencesbetween inelastic and elastic demand,and show students how elasticity is cal-culated. Then explain to students howelasticity of demand affects revenueand helps businesses plan for thefuture.3. Close/Reteach Point out that the demand for certain goods and servicesis highly sensitive to price fluctuations,whereas the demand for other goodsand services remains relatively unaf-fected. Ask students how they thinkproducers predict elasticity of demandfor a new product.

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Guided Reading and ReviewUnit 2 folder, p. 6 asks students toidentify the main ideas of the sectionand to define or identify key terms.

To help students transfer informationfrom one medium to another (writ-ten to visual), have them create illus-trations that demonstrate theprinciples of elastic and inelasticdemand. The illustrations can bedrawings, photographs, or photo-copies from magazines—anythingthat clarifies the concepts visually.Suggest that students with access toappropriate computer softwareenhance the clarity of their presenta-tions with its use.

Have students write down the mainheads and subheads for Section 3.Then ask them to write a sentence ortwo that summarizes the contentunder each head. LPR

Draw a grid on the chalkboard withthree columns and five lines. Labelthe first column “Product” and listthe names of several products: salt,steak, sports car, Picasso painting,chocolate bar. Label the second col-umn “Demand Elasticity.” Label thelast column “Reason.” Invite stu-dents, one at a time to come up andfill in “elastic” or “inelastic” for anyproduct and write a reason for theirchoice. Discuss the answers. SN

Math Practice ActivityMath Practice folder, p. 4,“Determining Elasticity of Demand,”gives students an opportunity to cal-culate elasticity of demand from dataabout price and quantity demanded.

Transparency Resource PackageEconomics Concepts, 4E:

Elasticity of Demand

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ChaptChapter er 44 •• Section Section 33

Supply and Demand If students are having troubleunderstanding elasticity of demand, show themseveral pieces of elastic. Then ask them to thinkabout the material that gives its name to the con-cept. When something is elastic, it can bestretched out and then returned to its originalshape. In a similar way, elastic demand

rises and falls—as easily as elastic can be stretchedout and snapped back. Material that is not elasticdoes not stretch; it remains the same. Show stu-dents a piece of tightly woven cloth to illustrateinelasticity. Inelastic demand remains the same,despite price fluctuations.

Econ 101: Key Concepts Made EasyEcon 101: Key Concepts Made Easy$

for a glossy magazine will be inelastic whenthe price rises 50 percent from 20 cents to30 cents. The price is still very low, andpeople will buy almost as many copies asthey did before. However, when the priceincreases 50 percent from $4.00 to $6.00,demand will be much more elastic. Manyreaders will refuse to pay $2.00 more forthe magazine. Yet in percentage terms, thechange in the magazine’s price is exactlythe same as when the price rose from 20cents to 30 cents.

Values of ElasticityWe have been using the terms inelastic andelastic to describe consumers’ responses toprice changes. These terms have precisemathematical definitions. If the elasticity ofdemand for a good at a certain price is lessthan 1, we describe demand as inelastic. Ifthe elasticity is greater than one, demand iselastic. If elasticity is exactly equal to 1, wedescribe demand as unitary elastic.

When elasticity of demand is unitary, thepercentage change in quantity demanded isexactly equal to the percentage change inthe price. Suppose the elasticity of demandfor a magazine at $2 is unitary. When theprice of the magazine rises by 50 percent to$3, the newsstand will sell exactly half asmany copies as before.

Think back to Ashley’s demand schedulefor pizza in Section 1. Ashley’s demandschedule shows that if the price per slicewere to rise from $1.00 to $1.50, herquantity demanded would fall from 4 slicesto 3 slices per day. The change in pricefrom $1.00 to $1.50 is a 50 percentincrease. The change in quantity demandedfrom 4 to 3 slices is a 25 percent decrease.Dividing the 25 percent decrease inquantity demanded by the 50 percentincrease in price gives us an elasticity ofdemand of 0.5.

Since Ashley’s elasticity of demand atprices of $1.00 to $1.50 is less than 1, wesay that Ashley’s demand for pizza isinelastic. In other words, a price increasehas a relatively small effect on the numberof slices of pizza she buys.

Suppose that we survey anothercustomer and find that, when the price ofpizza rises by 40 percent, this person’squantity demanded falls by 60 percent.The change in the quantity demanded of60 percent is divided by the change inprice of 40 percent, equaling an elasticityof demand of 1.5 (60 percent/40 percent =1.5). Since this result is greater than 1, thiscustomer’s demand is elastic. In otherwords, this customer is very sensitive tochanges in the price of pizza.

Factors Affecting Elasticity Why is the demand for some goods so muchless elastic than for other goods? Rephrasethe question and ask yourself, “What isessential to me? What goods must I have,even if the price rises greatly?” The goodsyou list might have some traits that set themapart from other goods and make yourdemand for those goods less elastic. Severaldifferent factors can affect a person’s elas-ticity of demand for a specific good.

Availability of Substitutes If there are few substitutes for a good, theneven when its price rises greatly, you mightstill buy it. You feel you have no good alter-natives. For example, if your favoritemusical group plans to give a concert, andyou want to attend, there really is nosubstitute for a ticket. You could go to aconcert to hear some other band, but thatwould not be as good. You’ve got to have

unitary elasticdescribes demandwhose elasticity isexactly equal to 1

Elasticity in the Kitchen Cooking varies from country tocountry, and so does elasticity of demand for certain foods. If the price of agallon of milk or a pound of ground beef doubled in the United States,consumers might demand intervention by the government. Do you think thiswould happen if the price rise affected onions and potatoes? These twovegetables are essential to Indian cooking, and when floods ruined crops inIndia, their prices more than doubled. In November 1998, angry citizens votedthe ruling party out of office in several states in part because of the high priceof onions.

Global Connections

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Ask students to interview classmates tocreate a demand schedule for one of thefollowing goods: popcorn at a movietheater, shoelaces, milk, or runningshoes. Tell them to draw a demandcurve that displays that schedule.Finally, ask them to write a paragraphthat explains the elasticity of demandfor that good as shown by the demandschedule and demand curve.

English language learners may benefitfrom working with a peer tutor inclass to learn how to calculate elastic-ity and to interpret the graphs on thispage. Pair proficient students withEnglish language learners, either one-on-one or as part of a larger group.Encourage students to share what theylearn. ELL

Have students examine the concept ofelasticity of demand by researchingairline ticket prices. Suggest that theychoose a destination and then checkfares for the next day, a month fromnow, and three months from now.Ask them to write a short report thatexamines differences in the elasticityof demand in those three situationsand the factors involved. GT

ChaptChapter er 44 •• Section Section 33

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Answer to . . . Building Key Concepts There willbe little change in quantitydemanded.

Consider these suggestions to take advantage ofextended class time:

� Extend the first activity on p. 91 by askinggroups of three or four students to combine theirindividual projects with narration, role-playing,audio accompaniment, or other techniques to createa group presentation on elasticity of demand. Giveeach group time in class to share its product.

� Extend the second activity on p. 94 by leadinga class discussion. Ask students to research the eth-ical issues of organ transplants. Then, in class,have students answer the question: “When, if ever,do medical ethics take precedence over the normaloperation of the free market?”

Block Scheduling StrategiesBlock Scheduling Strategies

Figure 4.7 Elasticity of DemandFigure 4.7 Elasticity of Demand

Quantity

Pri

ce

$7

$6

$5

$4

$3

$2

$1

5 10 15 20 25 30

Example 1: Elastic Demand

O

Quantity

Pri

ce

$7

$6

$5

$4

$3

$2

$1

Demand

5 10 15 20 25 30

Example 2: Inelastic Demand

O

Demand

Unitary elastic demand is a special case. When demand is unitary elastic, an increase (or decrease) in price will be met by an equal percentage decrease (or increase) in quantity demanded. Elasticity of demand is exactly 1.

To find the percentage change in quantity demanded or price, use the following formula: Subtract the new number from the original number, and divide the result by the original number. Ignore any negative signs, and multiply by 100 to convert this number to a percentage:

Percentage change in quantity demandedElasticity =

Elasticity is determined using the following formula:

Original number – New number Original number

x 100Percentage change =

If demand is elastic, a small change in price leads to a relatively large change in the quantity demanded. Follow this demand curve from left to right.

The price decreases from $4 to $3, a decrease of 25 percent.

The quantity demanded increases from 10 to 20. This isan increase of 100 percent.

Elasticity of demand is equal to 4.0. Elasticity is greater than 1, so demand is elastic. In this example, a small decrease in price caused a large increase in the quantity demanded.

If demand is inelastic, consumers are not very responsive to changes in price. A decrease in price will lead to only a small change in quantity demanded, or perhaps no change at all. Follow this demand curve from left to right as the price decreases sharply from $6 to $2.

The price decreases from $6 to $2, a decrease of about 67 percent.

The quantity demanded increases from 10 to 15, an increase of 50 percent.

Elasticity of demand is about 0.75. The elasticity is less than 1, so demand for this good is inelastic. The increase in quantity demanded is small compared to the decrease in price.

$4 – $3 $4

10 – 20 10

100% 25%

10 – 15 10

x 100 = 50

50% 67%

≈ 0.75

Percentage change in price

$6 – $2 $6

x 100 ≈ 67

x 100 = 25

x 100 = 100

= 4.0

Elasticity of demand describes how strongly consumerswill react to a change in price. Supply and Demand If a good’s elasticity of demand is0.2, how will consumers react to an increase in price?

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ChaptChapter er 44 •• Section Section 33

BackgroundEconomics in HistoryEconomics in HistoryCan yesterday’s luxury good everbecome today’s necessity? Theanswer is yes, and its elasticity ofdemand can change from very elas-tic to very inelastic. Here’s an inter-esting example.

Today the telephone is every-where. Most people cannot imaginelife without at least one. However,this was not always the case.

In 1920 only 35 percent of allhouseholds in the United States hada telephone. That figure jumped tonearly 41 percent by 1930. During thenext decade, however, the Great Depression ravaged the nation’seconomy, and for some families thetelephone was a luxury that theycould no longer afford. By 1940 thepercentage of households with atelephone actually dropped to about37 percent as families searched forways to spend less money.

After winning World War II, thenation’s military personnel camehome, fueling a demand for phoneservice. Approximately 60 percent ofUnited States households hadbecome telephone users by 1950.The numbers continued to rise until,by 1997, the figure had reachedabout 94 percent. What had oncebeen both a novelty and a luxury hadclearly become a necessity.

(Reteaching) Display the followinglist of goods: frozen orange juice,Italian sports car, insulin, cellularphone, and house or apartment. Thenwrite the following personal profile:Name—Alice; Age—55; YearlyIncome—$50,000; Occupation—SalesManager, Medical InstrumentsCorporation; Other factors—hasinsulin-dependent diabetes.

Ask each student to predict Alice’selasticity of demand for each of thefive goods. Ask students to speculateon how Alice’s elasticity of demand isaffected by substitute goods, the rela-tive importance of goods, necessitiesversus luxuries, and change over time.

Have students read the section titled “Factors Affecting Elasticity” and then answer thequestion below.Which of the following is not a factor that affects elasticity?

A availability of substitutes

B relative importance of a good

C necessities versus luxuries

D total revenue

Preparing for Standardized TestsPreparing for Standardized Tests��

tickets for this concert, and nothing elsewill do. Under these circumstances, amoderate change in price is not going tochange your mind. Your demand isinelastic.

Similarly, demand for life-savingmedicine is usually inelastic. For manyprescription drugs, the only possible substi-tute is to try an unproven treatment. Forthis reason, people with an illness willcontinue to buy as much needed medicineas they can afford, even when the pricegoes up.

If the lack of substitutes can makedemand inelastic, a wide choice of substi-tute goods can make demand elastic. Thedemand for a particular brand of applejuice is probably elastic because people canchoose from dozens of good substitutes ifthe price of their preferred brand rises.

Relative Importance A second factor in determining a good’selasticity of demand is how much of yourbudget you spend on the good. If youalready spend a large share of your incomeon a good, a price increase will force you tomake some tough choices. Unless you wantto cut back drastically on the other goodsin your budget, you must reduce consump-tion of that good by a significant amount tokeep your budget under control. The

higher the jump in price, the more you willhave to adjust your purchases.

If you currently spend half of yourbudget on clothes, then even a modestincrease in the cost of clothing willprobably cause a large reduction in thequantity you purchase. In other words,your demand will be elastic.

However, if the price of shoelacesdoubled, would you cut back on yourshoelace purchases? Probably not. Youmay not even notice the difference. Even ifyou spend twice as much on shoelaces, theywill still account for only a tiny part ofyour overall budget. Your demand forshoelaces is inelastic.

Necessities Versus LuxuriesThe third factor in determining a good’selasticity varies a great deal from person toperson, but it is nonetheless important.Whether a person considers a good to be anecessity or a luxury has a great impact onthe good’s elasticity of demand for thatperson. A necessity is a good people willalways buy, even when the price increases.Parents often regard milk as a necessity.They will buy it at any reasonable price. Ifthe price of a gallon of milk rises from$2.49 to $4.49, they will still buy as muchmilk as their children need to stay healthy.Their demand for milk is inelastic.

� Demand for some prescription drugs is relatively inelasticbecause the patient has few alternatives. Demand for anyone of these drinks would be much more elastic because aconsumer can easily find a less expensive choice.

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(Enrichment) As energy prices sky-rocketed in the 1970s, the UnitedStates government tried various waysto reduce the demand for fossil fuels,such as promoting alternate energysources and encouraging energy-savingpractices. Ask students to investigatethis period in history and report on theefforts undertaken by the governmentand how successful they were in reduc-ing demand. Tell them to consider whatthey have learned about the elasticity ofdemand for energy in their reports.

You may wish to have students addthe following to their portfolios.Explain to students that demand is not always just an economic principle. Itcan become an ethical issue as well. Asa result of advances in medical science,physicians are having great success inperforming organ transplants. Ask students if a person who has severeheart disease has an elastic or inelastic demand for a heart transplant. If thatdemand is inelastic—meaning thatprice is no object—should availableorgans be sold to the highest bidder?How should medical science addressthis highly personal and often time-sensitive issue of demand? Ask studentsto write a position paper detailing theirthoughts on the ethics of demand inrelation to organ transplants. GT

Economics Assessment RubricEconomics Assessment Rubrics folder,pp. 22–23 provides sample evaluationmaterials for a position paper.

ChaptChapter er 44 •• Section Section 33

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Literary Demand Students may not realize it, but lit-erature is quite responsive to demand. EvenCharles Dickens, today considered a classic author,created plots and characters in response to his readers’ likes and dislikes. Today the current best-sellers, whether they are historical romances, detec-tive thrillers, or government spy capers, are sure tospawn plenty of imitations.

Making the Connection Ask students whether thedemand for books is elastic or inelastic and why.Then ask if they can think of any book or type ofbook that people would buy even at a very highprice. (Students may suggest volumes of great per-sonal value, such as religious texts, or referencebooks such as dictionaries or encyclopedias. Somestudents will suggest that the availability of on-lineinformation makes the demand for books moreelastic.)

Interdisciplinary Connections: LiteratureInterdisciplinary Connections: Literature

The same parents may regard steak as aluxury. When the price of steak increasesby a little bit, say 20 percent, parents maycut their monthly purchases of steak bymore than 20 percent, or skip steak alto-gether. Steak is a luxury, and consumerscan easily reduce the quantity theyconsume. Because it is easy to reduce thequantity of luxuries demanded, demand iselastic.

Change over TimeWhen a price changes, consumers oftenneed time to change their shopping habits.Consumers do not always react quickly toa price increase because it takes time to findsubstitutes. Because they cannot respondquickly to price changes, their demand isinelastic in the short term. Demand some-times becomes more elastic over time,however, because people can eventuallyfind substitutes that allow large adjust-ments to what they buy.

Consider the example of gasoline. Whena person purchases a vehicle, he or shemight choose a large vehicle that requires agreater volume of gasoline per mile to run.This same person might work at a jobmany miles away from home and shop at a

supermarket that is far from both workand home. These factors determine howmuch gasoline this person demands, andnone can be changed easily.

In the early 1970s, several oil-rich coun-tries cut their oil exports to the UnitedStates, and gasoline prices rose quickly. Inthe short run, there was very little thatpeople could do to reduce their consump-tion of gasoline. They still needed to driveto school and work. At first, drivers weremore likely to pay more for the sameamount of gasoline than they were to buyfuel-efficient cars or move closer to theirschools and workplaces.

However, because gas prices stayed highfor a considerable period of time, somepeople eventually switched to more fuel-efficient cars. Others formed car pools,walked or rode bicycles, and used publictransportation. In the long run, peoplereduced their consumption of gasoline byfinding substitutes. Demand for gasoline,inelastic in the short term, is more elastic inthe long term.

As another example, consider whathappened to gasoline prices from the early1980s through the early 2000s. Adjustingfor inflation, the price of a gallon of gas fell

� When gas prices rose in the 1970s, auto manufacturers advertised how little fuel their cars used. In recent years when gas prices were low, new advertisingemphasized strength and size, even though those cars used more gasoline.

� Many peopleconsider lobster aluxury and caneasily cut it out oftheir budget.

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Ask students to rewrite the followingincorrect statements so that they aretrue:• Your demand for a good that you

will keep buying despite a priceincrease is elastic. (inelastic)

• If demand for a good is elastic atone price it will be elastic at everyprice. (may be inelastic at a differ-ent price)

• If the elasticity of demand for agood is less than one, the demandis unitary elastic. (exactly equal to)

• Demand for a lifesaving medicineis usually elastic. (inelastic)

• Demand for a luxury is usuallyinelastic. (elastic) LPR

Have students analyze the types ofproducers below and make predic-tions on which can expect a revenueincrease from higher prices andwhich can expect a revenue decrease.Ask them to explain how theyarrived at their conclusions.• a pharmaceutical company

(increase because demand is prob-ably inelastic)

• a company that produces enter-tainment software (decreasebecause demand is elastic)

• a power supplier (increase becausedemand is inelastic)

• a sportswear manufacturer(decrease because demand iselastic)

• an organic egg producer (decreasebecause demand is elastic)

Economic Detective ActivityUnit 2 folder, p. 10, “Mars Station,”provides an integrated application ofchapter concepts.

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ChaptChapter er 44 •• Section Section 33

Answer to . . .Building Key Concepts inelastic

Have students read the section titled “Elasticity and Revenue” and then answer the ques-tion below.

Which of the following shows the relationship of elastic demand to total revenue?

A prices rise, demand falls, revenues decrease

B prices rise, demand rises, revenues increase

C prices fall, demand falls, revenues decrease

D prices rise, demand rises, revenues decrease

Preparing for Standardized TestsPreparing for Standardized Tests��

considerably from its highs in the 1970s. Inaddition, gasoline prices remained low formany years. At first, people continued toseek out fuel-efficient cars. Over time,however, many Americans switched backto larger vehicles that get fewer miles to thegallon. Because the price of gas remainedlow, people gradually adjusted their habitsto use more and more gasoline. Just asdemand for gasoline responded slowly toan increase in price, it also respondedslowly to a decrease in price.

Elasticity and Revenue Elasticity is important to the study ofeconomics because elasticity helps usmeasure how consumers respond to pricechanges for different products. Elasticity isalso an important tool for businessplanners like the pizzeria owner describedin Sections 1 and 2. The elasticity ofdemand determines how a change in priceswill affect a firm’s total revenue or income.

Computing a Firm’s Total Revenue A company’s total revenue is defined as theamount of money the company receives byselling its goods. This is determined by twofactors: the price of the goods and thequantity sold. If a pizzeria sells 125 slices ofpizza per day at $2.00 per slice, totalrevenue would be $250 per day.

Total Revenue and Elastic Demand The law of demand tells us that an increasein price will decrease the quantitydemanded. When a good has an elasticdemand, raising the price of each unit soldby 20 percent will decrease the quantitysold by a larger percentage, say 50 percent.The quantity sold will drop enough toactually reduce the firm’s total revenue.Figure 4.8, drawn from the demand curvefor the pizzeria, shows how this canhappen. An increase in price from $2.50 to$3.00, or 20 percent, decreases thequantity sold from 100 to 50, or 50percent. As a result, total revenue dropsfrom $250 to $150.

The same process can also work inreverse. If the firm were to reduce the priceby a certain percentage, the quantitydemanded could rise by an even greaterpercentage. In this case, total revenuescould rise.

It may surprise you that a firm couldlose revenue by raising the price of itsgoods. But if the pizzeria started sellingpizza at $10 a slice, it would not stay inbusiness very long. Remember that elasticdemand comes from one or more of thesefactors:

1. availability of substitute goods 2. a limited budget that does not allow

price changes3. the perception of the good as a

luxury item

If these conditions are present, then thedemand for the good is elastic, and a firmmay find that a price increase reduces itstotal revenue.

Total Revenue and Inelastic Demand Remember that if demand is inelastic,consumers’ demand is not very responsiveto price changes. Thus, if the firm raises itsprice by 25 percent, the quantity demandedwill fall, but by less than 25 percent. Thefirm will have greater total revenues. Inother words, the higher price makes up forthe firm’s lower sales, and the firm brings inmore money.

total revenue the totalamount of money a firmreceives by sellinggoods or services

Price of a sliceof pizza

Quantity demandedper day

300250200150100

50

Total revenue

$150$250$300$300$250$150

$ .50$1.00$1.50$2.00$2.50$3.00

Figure 4.8 Revenue TableFigure 4.8 Revenue Table

Setting prices too high or too low can hurt revenue.Markets and Prices When the price doubles from$.50 to $1.00, is demand elastic, unitary elastic, orinelastic?

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Guide to the EssentialsChapter 4, Section 3, p. 18 providessupport for students who need addi-tional review of the section content.Spanish support is available in theSpanish edition of the guide on p. 18.

Quiz Unit 2 folder, p. 7 includesquestions to check students’ under-standing of Section 3 content.

Presentation Pro CD-ROM Quiz provides multiple-choice

questions to check students’ under-standing of Section 3 content.

Answers to . . .

Section 3 AssessmentSection 3 Assessment1. Elasticity of demand measures how

drastically buyers will increase or decrease their demand for a goodwhen the price rises or falls. (Exactwording will vary.)

2. Answers will vary. Students may suggest clothing or compact discs.

3. The low temperature requires peopleto heat their homes, thus creating aninelastic demand for heating fuel.

4. Total revenue is determined by multi-plying the quantity of goods sold bythe price charged.

5. (a) 2: elastic (60 – 48 = 12, or 20 per-cent; 11 – 10 = 1, or 10 percent 20 ÷ 10 = 2 (b) 0.25: inelastic (82 – 80 = 2, or 2.5 percent; 60 – 54 = 6,or 10 percent 2.5 ÷ 10 = 0.25)

6. Students should provide evidence oftheir interviews along with an analysisof the factors determining elasticity.

7. Examples might include alternativefuel sources becoming more popularand easier to use, thus causingdemand for gasoline to decrease.

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Answer to . . . Building Key Concepts Elasticdemand means that people will buyless if prices rise. When people buyless, revenue falls.

On the other hand, a decrease in pricewill lead to an increase in the quantitydemanded if demand is inelastic. However,demand will not rise as much, in percentageterms, as the price fell, and the firm’s totalrevenue will decrease.

Elasticity and Pricing PoliciesBecause of these relationships, a firm needsto know whether the demand for itsproduct is elastic or inelastic at a givenprice. This knowledge helps the firm make

pricing decisions that lead to the greatestrevenue. If a firm knows that the demandfor its product is elastic at the currentprice, it knows that an increase in pricewould reduce total revenues. On the otherhand, if a firm knows that the demand forits product is inelastic at its current price, itknows that an increase in price willincrease total revenue. In the next chapter,you will read more about the choicesproducers make to reach an ideal level ofrevenue.

Section 3 Assessment

Key Terms and Main Ideas1. Explain elasticity of demand in your own words.2. Name a good with elastic demand at its current price. 3. Why is demand for home heating fuel inelastic in cold

weather?4. How do we calculate total revenue?

Applying Economic Concepts5. Math Practice Use the formula in Figure 4.7 to calculate

the exact elasticity of demand in the following examples.Then tell if, in each case, demand is elastic, inelastic, orunitary elastic. (a) When the price of a deluxe car washrises from $10.00 to $11.00, the number of dailycustomers falls from 60 to 48. (b) A dentist with 80patients cuts his fee for a cleaning from $60.00 to $54.00and attracts two new patients.

6. Try This Interview a manager at a local restaurant orstore. Ask if he or she has changed the price of any goodor service in the past year, and if so, how sales wereaffected. Is demand for each of these goods or serviceselastic or inelastic? What factors might explain youranswer?

7. Critical Thinking Think of a good, like gasoline, forwhich demand can become more elastic over time.What changes can take place in the long term to affectdemand?

Figure 4.9 Elasticity and RevenueFigure 4.9 Elasticity and Revenue

As the price is

lowered . . .

Totalrevenue

rises

Totalrevenue

falls

As the price is

lowered . . .

Totalrevenue

falls

As the price is

raised . . .

Totalrevenue

rises

Elastic Demand Inelastic Demand

As the price is

raised . . .

Elasticity of demand determines the effect of a price change on total revenues. Markets and Prices Why will revenue fall if a firm raises the price of a goodwhose demand is elastic?

PHSchool.com

For: Math ActivityVisit: PHSchool.comWeb Code: mnd-2043

Progress Monitoring OnlineFor: Self-quiz with vocabulary practiceWeb Code: mna-2047

Typing in the Web Codewhen prompted will bring students directlyto detailed instructions for this activity.

Progress Monitoring OnlineFor additional assessment, have students accessProgress Monitoring Online at Web Code: mna-2047