Elasticity of Demand
How sensitive is demand to price changes?
Slope of Demand Curves
• Demand curves do not all have the same slope
• Slope indicates response of buyers to a change in price
Price ↑ 10%
=>
Qty Demanded ↓ ? (how much?)
Price
D1
D1
D1
Qty
Which demand curve is most sensitive to price changes?
ELASTICITY OF DEMAND
• Elasticity of demand (Ed) measures the sensitivity of quantity
demanded in response to a change in price:
Ed = % change Qty D
% change Price
Elastic Demand Curves
• Elastic Demand
– Demand is sensitive to price changes
– Demand Curves are flat
– Ed > 1
Px
D1
Qty
– A % ↑ Price leads to a greater % decline in Qty Demanded
Ed = % change Qty D
% change Price
Example:
Elastic Demand Curve
.
10% rise in Price
causes a Greater
than 10 % decline
in Qty D
Ed = 1.5
Ed = % change Qty D
% change Price
Inelastic Demand Curves
• Inelastic Demand
Px
– Demand NOT sensitive to price changes
– Curves are STEEP
– Ed < 1
D1
Qty
– A % ↑ Price leads to a SMALLER % decline in Qty Demanded
Ed = % change Qty D
% change Price
Example:
Inelastic Demand Curve
↑% Price changes
Leads to a smaller
% decline in Qty D
+100%
Ed = 0.1
Quantity
-10%
Ed = % change Qty D
% change Price
Elasticity depends on:
• Number of close substitutes
– more substitutes => more elastic demand
• Whether the good is considered a necessity
– Necessities tend to be inelastic, luxury goods are elastic
• Proportion of income spent
– larger proportion of income more elastic
• Time period
– Longer the time period => the more elastic demand is
Price Elastic or Price Inelastic?
Gasoline
Soda
Price Inelastic
Price Elastic
No real substitutes
Many substitutes
Heart Surgery
Table Salt
Price Inelastic
Price Inelastic
Necessity &
No real substitutes,
Short time period
Small proportion
of income, no good
substitute
Total Revenue & Profit
• Total Revenue = Price X Quantity
• Profit = Total Revenue - Expenses
Elasticity determines the effect on total revenue
Total Revenue
=> when Prices
elastic goods
Total Revenue
=> when Prices
inelastic goods
Elastic Demand
Raising prices will
lower total revenue!
$200
$150
200
300
Elasticity Worksheet
Elastic Demand
Inelastic Demand
Px
Px
D1
D1
Qty
Qty
Total Revenue =
Price * Quantity
GDP