Elasticity of demand practice

3.03 Notes Guide

Elasticity of Demand

Normal Goods vs. Inferior Goods

Before we get to elasticity, we need to mention 1. Normal Goods and 2.Inferior Goods.

Goods can be classified as normal goods or inferior goods. This classification has nothing to do with the quality of a good, but rather with whether we buy more or less of a good depending on our income. 

Most goods are normal goods. If we make more money, we will purchase more of that good.

Example: 3. Movie Tickets

Other goods, inferior goods, show an opposite trend. When our income decreases, we purchase more of these products because it is more cost effective.

4. Generic items and 5. Used Items

Demand Elasticity

6. Elasticity measures how sensitive consumers are to price change.

Demand is 7. Elastic when a change in price causes a large change in demand.

Demand Elasticity Continued

Demand is 8. Inelastic when a change in price causes a small change in demand.

Demand is 9. Unit elastic when a change in price causes a proportional change in demand.

Determinants of Demand Elasticity

There are three questions about a product that give us a reasonably good idea as to a product’s demand elasticity.

1. Can the purchase be delayed?

• Some purchases cannot be delayed, regardless of price changes.

2. Are adequate substitutions available?

• Price changes can cause consumers to substitute one product for a similar product
• If an item has many close substitutes it tends to have an elastic demand because consumers can switch among substitutes.

3. Does the purchase use a large portion of income?

• Demand elasticity can increase when a product commands a large portion of a consumer’s income.

The Total Expenditures Test

Price x Quantity = 13. Total Expendures

Understanding the relationship between elasticity and profits can help producers effectively price their products.

Review What You Learned

Explain the three determinants of demand elasticity.

14. Elastic is when a change in the price causes a large change in demand. Inelastic is when a change in price causes a small change in demand. Unit elastic is when change prices makes a proportional change in demand.

Explain why an item that has many close substitutes tends to have an elastic demand.

15. If an item has many close substitutes it tends to have an elastic demand because consumers can switch among substitutes.