Elasticity of Demand

How sensitive is demand?

Slope of a Demand Curve

• What does slope indicate about a product?

• Do all demand Curves have the same slope?

Demand Curves

Slope of Demand Curve

• Indicates the responsiveness of Quantity Demanded to a change in Price.

• If the price of a good increases 20% =>

how much does QTY demand decrease?

Elastic Goods

• Elastic demand curves are flat– Sensitive to price changes

• A ↑ Price leads to a greater ↓ in Qty Demanded

D1

Px

Qty

Inelastic Goods

• Inelastic goods are NOT sensitive to price changes

• % Change in Price leads to a Smaller % change in Qty Demanded

Inelastic Goods

• Inelastic demand curves are steep– Not Sensitive to price changes

• A ↑ Price leads to a smaller ↓ in Qty Demanded

D1

Px

Qty

Elasticity depends on:

• # of close substitutes

• Necessity

• Proportion of income spent

• Time period

Price Elastic or Price Inelastic?

Soda

Heart Surgery Table Salt

Gasoline

Price Inelastic

No real substitutes

Price Inelastic

Necessity &No real substitutes,Short time period

Price Elastic

Many substitutes

Price Inelastic

Small proportionof income, no goodsubstitute

Elastic Goods Inelastic Goods

Why does a business Care?

• Total Revenue

• Price * Quantity = Total Revenue

Elasticity determines the effect on total revenue

Total Revenue & Inelastic Demand

Total Revenue & Elastic Demand

Total Revenue Profit

Total Revenue - Total Expenses = Profit

What you need to know!

• More elastic demand curves are flat

• Elastic means Qty D is sensitive to Px Changes

• Total Revenue => Prices elastic goods

• Total Revenue => Prices inelastic goods

Elasticity of Demand Practice Problems PROBLEM #1 • Consider the degree of elasticity of demand for hard candy. Draw the Demand Curve for

hard candy with your best educated guess about the proper slope for its elasticity/inelasticity.

• Label a point on the demand curve Point E (for equilibrium. Show on the x and y axis that at Point E the equilibrium price and quantity demanded are P=$2 per pound Qty Demanded=1000 pounds

• Now, imagine that Candy Manufacturers raise the price of a pound of candy from $2/pound to $4/pound; locate the new point on the demand curve that shows the quantity demanded at $4 per pound.

• With such a price change, would total revenue increase or decrease? Show this graphically and explain in writing why this is so.

PROBLEM #2 • Consider the degree of elasticity of demand for gasoline.Draw the Demand Curve for gasoline

with your best educated guess about the proper slope for its elasticity/inelasticity.

• Label a point on the demand curve Point E (for equilibrium. Show on the x and y axis that at Point E the equilibrium price and quantity demanded are P=$3 per gallon Qty Demanded=gallons

• Now, imagine that Oil Manufacturers raise the price of a gallon of gasoline from $3/gallon to $5/gallon; locate the new point on the demand curve that shows the quantity demanded at $5/gallon.

• With such a price change, would total revenue increase or decrease? Show this graphically and explain in writing why this is so.

ELASTIC DEMAND INELASTIC DEMAND

Total Revenue & Inelastic Demand

$10

$6

D1

.

Price increases from $6 to $10

Total Revenue increases from A to B

A = $10 * 18 = $180

B = $6 * 20 = $120

.2018

Total Revenue & Elastic Demand

Price

Quantity

D1

Elastic Goods

• Elastic goods have demand which is very sensitive to price changes

• A % Change in Price leads to a greater % change in Qty Demanded.

Inelastic Demand Curve

PRICE

Quantity

Elastic Demand Curve

PRICE

Quantity

Inelastic or Elastic?

Gasoline Soda

Heart SurgeryTable Salt

Total Revenue & Inelastic Demand

$10

$6

D1

Total Revenue