Elasticity of Demand

Elasticity of DemandBy: Sam D. FuegoSchool of Liberal ArtsAteneo de Zamboanga University

Learning ObjectivesExpress and calculate price elasticity of demand;

Understand the economic significance of price elasticity of demand and total revenues, and

Discuss the factors that determine the price elasticity of demand.

Elasticity of DemandDemand elasticity refers to the reaction or response of the buyers to changes in price of goods and services.Buyers tend to reduce their purchases as price increases, and tend to increase their purchases whenever price falls.These are logical reactions to price changes.However, such reactions vary in accordance with the nature of the products and the particular needs of the buyers.

Elasticity of DemandFor example, if a product is very important to the consumers, they have to buy it despite the big increase in its price.There are products with just a slight increase in their prices, but many consumers are reluctant to buy.These products are not important to them.They can still live without said products.

Types of demand elasticityElastic demandA change in price results to a greater change in quantity demanded.For example, a 20 percent change in price (decrease or increase) creates a 60 percent change in quantity demanded(increase or decrease).This shows buyers are very sensitive to price change. They are easily discouraged to buy the products if their prices increase.However, they are easily encouraged to buy the same products if their prices decrease.

Types of demand elasticitySuch products are not very important to them, but they provide comforts and pleasure to the consumers.These are the luxury goods like stereo, radio, camera, etc.

Types of demand elasticity2. Inelastic demandA change in price results to a less change in quantity demanded.For example, a 50 percent change in price creates only a 5 percent change in quantity demanded.This means buyers are not sensitive to price change.Products under this category are very essential to buyers.They cannot live without them or it is hard to live without such products.

Types of demand elasticityProducts like rice, medicine, shelter or cell phone.However, a big decrease in the prices of the these products has a very little increase in quantity demanded. For example, a great decline in the prices of rice and medicine does not encourage people to eat more rice or take more medicine.They only buy as much as the requirement of their normal consumption.

Types of demand elasticity3. Unitary demandA change in price results to an equal change in quantity demanded.For example, a 25 percent change in price produces a 25 percent change in quantity demanded.Goods or services under this category are considered semi-luxury or semi-essential goods.Some types of clothing or shoes are either luxury or essential good.

Extreme Price ElasticitiesPerfectly Inelastic DemandA demand curve that is a vertical line.It has only one quantity demanded for each price.No matter what the price, quantity demanded does not change.This is an extreme situation which involves life or death to an individual.Regardless of price, he has to buy the product like medicine with no substitute.

Extreme Price ElasticitiesPerfectly Elastic DemandA demand curve that is a horizontal line.It has only one price for every quantity.Without change in price, there is an infinite change in quantity demanded.

Types of demand elasticity showing the various degrees of reactions of buyers brought about by price change.

P

0 Q Elastic P

0 Q Inelastic

Types of demand elasticity showing the various degrees of reactions of buyers brought about by price change.P

D

0 Perfectly Elastic P D

0 Perfectly Inelastic

Determinants of Demand ElasticityNumber of good substitutesDemand is elastic for a product with many good substitutes. An increase in the price of such product induces buyers to look for good substitutes.On the other hand, products without good substitutes have inelastic demand. Buyers have little or no choice except to purchase them if they really need them. E.g. electricity.

Determinants of Demand Elasticity2. Price increase in proportion to incomeIf the price increase has very little effect on the income or budget of the buyers, demand is inelastic.For example, a 40 percent increase in the price of bread means only a few centavos. Thus, the result is only slight decrease in quantity demanded.But if the price involves a substantial amount in proportion to the income of consumers, demand is elastic.For example, a 40 percent increase in tuition fees is likely to discourage many very poor families from sending their children to college.

Determinants of Demand Elasticity3. Importance of the product to the consumersLuxury goods are not very important to many Filipinos. Examples are diamond rings, sport cars, expensive wines, elegant clothing, etc. So, these are elastic.On the other hand, essential goods are very important to people. Rice is important to all consumers. Electricity is important to factory owners. Gasoline is important to the transportation industry. All of these are inelastic.

Elasticity Formula

change in Q(Q1 + Q2)/2Ep =change in P(P1 + P2)/2Elasticity formula:Change in Quantity refers to the difference between the original quantity and the new quantity. Disregard negative sign. Change in Pricerefers to the difference between the original price and the new price. Disregard negative sign.

PROBLEMYearQuantity DemandedPrice200110,00040020026,00060020038,000500200415,00040020057,000600200610,000300200711,00020020085,00080020095,00060020104,00090020116,000700

QUIZ 1Given the table, solve for Ed :Year 2001-2002Year 2002-2003Year 2005-2006Year 2008-2009 Year 2009-2010 a). And tell whether it is elastic, inelastic or unitary. Round off only the final answer to the nearest hundredths. GRAPH your answer.b). Which one is more elastic, Year 2005-2006 or Year 2008-2009? Explain.