Price Elasticity of Demand
• If you were planning to have a
pizza for dinner and saw a sign in
your favorite pizza restaurant that
read…
Due to increases in the cost of
cheese - all items on the menu
have been increased by $3.00
until further notice
Would you still go in and
order pizza for dinner?
Suppose you notice the fuel indicator
on your car pointing to 'Empty’. As you
pull into the gas station, you see the
price of gasoline has risen by $.50 a
gallon.
• Do you still get gas?
The answers to these questions may
well depend on the
price elasticity
of demand.
In this lesson, you will learn about
•
•
•
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the law of demand,
the definition of price elasticity of demand,
how we measure price elasticity of demand
some actual price-elasticity measurements
for various goods,
• and why different goods have different goods
differ in price elasticity.
I know that you have studied
the law of demand?
• This economic principle says that we will buy
less of a good if the price rises, and vice versa.
• You can probably think of many goods you buy
that would meet the law of demand.
• There are other goods that seem to defy the
law of demand, but this may be due to the
price elasticity of the good.
What is the price elasticity of demand?
It is a measure of the responsiveness
of quantity demanded to a price
change.
• In other words, if the price of a good
changes, do we change the quantity
we buy?
• In the pizza example, many of us would not
get pizza but would go to another restaurant
(or eat at home) if prices increased by $3.00.
• But we probably would still fill up our car with
gasoline even if the price were increased by
50 cents per gallon.
Why?
• Because restaurant meals and gasoline have
very different price elasticity.
Gasoline is considered inelastic (meaning price
changes have little effect on the quantity we
buy). Inelastic demand curves tend to be more
vertical.
Restaurant meals, on the other hand,
are very elastic (meaning price
changes greatly affect our purchase of
them).
• Elastic demand curves
are more horizontal
There are several factors that affect
the price elasticity of a good.
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These include the following:
Availability of substitutes
The degree of necessity
The proportion of a purchaser's budget
consumed by the item
• The time period involved.
Substitutes
• If a good has a large number of substitutes,
we can pick a substitute if the price rises on
the good. For example, if beef has a price
increase, we might substitute chicken, pork or
fish.
• Perfume is not considered something that you
need for survival but if you're a diabetic,
insulin is.
If the good consumes a relatively small proportion of
your budget, price changes do not greatly affect the
amount you buy.
• For example, if you buy a couple of packages
of gum every month and that represents a
very small percentage of your budget• Then, a price increase of 20 percent (say from
$1 to $1.20) probably would not affect your
quantity purchased.
The time period involved is also a
factor in price elasticity.
• If you have a short period to make a decision,
you may have to accept price changes. But in
the long run, you can change your
consumption of this good or brand in some
cases.
• In other words, you have time to vary the
amount purchased or the price you pay.
Now let's compare gasoline and
restaurant meals.
• Elasticity worksheet
http://www.econedlink.org/lessons/EconEdLi
nk-flashinteractive.php?filename=em551_comparing_
list2.swf&lid=551
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How does a person calculate elasticity?
If you calculate the elasticity ratio
using that formula, then…
• If the elasticity ratio is less than 1, the demand
for the good is considered inelastic.
• If the elasticity ratio is greater than 1, the
demand for the good is elastic.
• Unitary elasticity is when the elasticity ratio is
approximately 1 (which means the percentage
change in quantity demanded is about the
same as the percentage change in price).
ASSESSMENT ACTIVITY
• Look at elasticity of the various goods on
the Mackinac Center for Public Policy, and
see if you can determine if they are
inelastic, elastic, or unitary elastic, and
why-http://www.mackinaw.org/article.aspx?ID=1247
Here is a short video describing
elasticity
• http://www.youtube.com/watch?v=4oj_lnj6p
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