Elasticity of Demand

Elasticity of Demand pertains to the relationship of price and need of a product. If a price increases will the demand increase or decrease? When a demand is elastic, it means even a small change in price can cause a large change in the quantities consumers purchase. (McConnell, pg. 77) So for example in an elastic demand if you reduce the price of a good the demand will increase a large amount and revenue then increases. When the is inelastic, according to McConnell it means when there is a price change it only causes a small change in the amounts consumer purchase. This can result in less total revenue. If a company drops the price of something, even if they sell more it doesn’t mean they will make more overall. If it is inelastic, the revenue can drop. There is also something called perfectly inelastic, which means and change in price results in absolutely no change in demand. This is rare and an extreme situation. There is also demand in unit elastic which “demands occurs where a percentage change in price and the resulting percentage change in quantity demanded are the same”. (McConnell, pg. 77) B)

Cross elasticity of demand measures two different products and their response to price changes. So if a consumer purchases one product cross elasticity measures how sensitive that consumer is to the change in the price of another product. It is measured by the percentage changes in demand for the first product that occurs in response to a percentage change in price of the second good. (McConnell, pg. 87) Substitute goods play a roll is this because this can be used with different brands. Say consumers buy toothpaste, they could buy Colgate or Crest. These would be substitute products. Or if they buy chips, Doritos or Lays. When the cross elasticity is positive it means if the price would increase in the Colgate, the demand for the substitute good, in this case Crest, would go up. This would go up because if Colgate is more expensive than Crest because of the price increase, consumers would buy the lower priced item.

The larger the positive cross-elasticity means the larger the substitutability between these products. (McConnell pg. 88) A complementary goods are goods that relate to one another. So for example coffee and coffee filters, chips and salsa or hamburgers and buns. These are goods that are usually bought together. So if the price of coffee goes up and the consumption goes down, then the demand for the coffee filters would go down as well. This is called negative cross elasticity. The larger the negative cross-elasticity coefficient means the more complementary these goods are. (McConnell, pg. 88) C) Income Elasticity means the relationship between a change in a consumer’s income and if that consumer is buying more or less of a particular product. Normal goods, or superior goods are usually demanded more as income rises. Examples of these are luxury items. For example salmon, wine, or specialty cheeses.

These are sometimes not purchased below a certain level of income. Inferior goods are purchased less as income rises. Examples of these could be used clothing, own-brand foods, bus tickets vs. plane tickets. Plane tickets being the superior good and a bus ticket the inferior good. D) If there are substitutes for a product available the demand tends to be relatively elastic. The reason for this is because for example if a consumer purchases Coke, then the price goes up $.50 per case to $4.00 a case and Pepsi is still $3.50 the consumer will most likely switch to Pepsi. The reason for this is because for most Pepsi is pretty much the exact same product as Coke and they will save money by buying the cheaper product. This is why the demand is elastic.

If the price changes even a little bit you can still see a large change in demand for the product if there is a suitable substitute on the market for that product. If Coke was the only soda of its type in the supermarket and there wasn’t an available substitute the $.50 price change might actually become Inelastic. Since the price change is so small, the demand for the product might not change much, but because of the availability of a similar, cheaper product, the demand is Elastic. E) The proportions of income devoted to a good can make the price change for that good become elastic or inelastic depending on the percentage of a consumers income is spent on that good. For example, if you go grocery shopping with a budget of $100 and always buy a pack of gum that is $1.00 and is 1% of your budget. If that gum price goes up 10% to $1.10- that 10% has only increased your that part of your budget to 1.1%. So you will still purchase that pack of gum therefore the price increase is inelastic. If you normally buy wine for $20 and it goes up 10% it is now $22.

It was 20% of your budget, now it’s 22% of your budget. So it cut into your budget by 2%. The price change on this will probably effect if you purchase this product or not, making this price change elastic. Both of these price changes for 10% but they were a different proportion and percentage of your income so this can effect weather it is elastic or inelastic. F) Short run is defined by McConnell as a period of time in which one or more inputs are fixed but outputs can vary. Long run is defined as a period of time input and outputs can vary. If a consumer is faced with a large one time price increase this will cause some price inelasticity in the short term.

It becomes more elastic as time goes on. The reason for this for example is if chicken prices sky rocket, then consumers will just try to buy less chicken, but overall this won’t effect much of the demand because the consumers will still eat meat with their dinner. In the long run consumers start to adjust to the change in price and start using substitutes for the good. So instead of chicken consumers may now start to buy Turkey. The more consumers do this, the less chicken they are going to buy as time goes on. The reason that the price elasticity if greater in the long run is because business’s now try to develop like items to compete with the competitors price increase. G)

The price range that the demand curve is elastic from greater than $50, Unit elastic at $40 to $50 and Inelastic less than $40. G1)
For the Elastic demand, the Total revenue went from $80 to $200, so it went up. For unit Elastic total revenue remained at $200. For the Inelastic demand the total revenue went from $200 down to $0. H)

McConnell, Campbell. Economics. 19th Edition. McGraw-Hill Learning Solutions, 2011. VitalBook file. Bookshelf.