The law of demand states that consumers will buy more when prices go down, and buy less when prices go up. This matters so that producers can know how much more to make.
Elasticity shows how sensitive the quantity is to a change in price. Therefore, elasticity of demand:
- Measurement of consumers responsiveness to a change in price
- Essentially, what will happen if the price increases? How much will it affect the quantity demanded?
This is used by:
- firms, to determine prices+sales
- government, to decide how to tax
Total Revenue Test: Use elasticity to show how changes in price will affect total revenue (TR = price x quantity) Unit Elastic: Price changes and total revenue remains unchanged. Ex: if demand for milk is inelastic, what will happen to expenditures on milk if prices increase?
Elastic Demand
Elastic: Quantity is sensitive to a change in price. If the price increases, the quantity demanded will fall a lot. If the price decreases, the quantity demanded will increase a lot. The amount of purchasers is sensitive. Elastic demand curves are flat. Ex: soda, boats, beef
- Price increase causes total revenue to decrease
- Price decrease causes total revenue to increase
General Characteristics of Elastic Goods:
- Luxuries
- Many substitutes
- A large portion of income
- Plenty of time to decide
- Elasticity coefficient > 1
Inelastic Demand
Inelastic: Quantity is insensitive to a change in price. If the price increases, the quantity demanded will fall a little. If the price decreases, the quantity demanded will increase slightly, but people will continue to buy it. Ex: milk, diapers, basic needs
- Price increase causes total revenue to increase
- Price decrease causes total revenue to decrease
General Characteristics of Inelastic Goods:
- Necessities
- Fewer substitutes
- A small portion of income
- Required urgently
See also: 2.4 β Elasticity of Supply and 2.5 β Other Elasticities.