2. Imagine you design websites for local
businesses. You charge $200 per website, and
currently sell 12 websites per month.
Your costs are rising (including the opportunity
cost of your time), so you consider raising the
price to $250.
What do you think is going to happen to your
revenue? Why?
A scenario…
2Elasticity | Part 1
3. What determines price elasticity?
To learn the determinants of price elasticity, we look at a
series of examples. Each compares two common goods.
In each example:
• Suppose the prices of both goods rise by 20%.
• The good with the more elastic demand is the good for
which Qd (the Quantity demanded – or more simply, the
amount sold) falls the most (in percent).
• What lesson does the example teach us about what
determines how price elastic (or responsive) demand for a
good is?
4. EXAMPLE 1 | Breakfast Cereal vs. Sunscreen
• The prices of both of these goods rise by 20%.
For which good does Qd drop the most? Why?
• Breakfast cereal has close substitutes
(e.g., pancakes, Eggo waffles, leftover pizza),
so buyers can easily switch if the price rises.
• Sunscreen has no close substitutes,
so a price increase would not affect demand very much.
• Lesson: Price elasticity is higher when close
substitutes are available.
5. EXAMPLE 2 | “Blue Jeans” vs. “Clothing”
• The prices of both goods rise by 20%.
For which good does Qd drop the most? Why?
• For a narrowly defined good such as
blue jeans, there are many substitutes
(khakis, shorts, Speedos).
• There are fewer substitutes available for broadly defined
goods.
(Are there any substitutes for clothing?)
• Lesson: Price elasticity is higher for narrowly defined
goods than for broadly defined ones.
6. EXAMPLE 3 |Insulin vs. Caribbean Cruises
• The prices of both of these goods rise by 20%.
For which good does Qd drop the most? Why?
• To millions of diabetics, insulin is a necessity.
A rise in its price would cause little or no decrease in
demand.
• A cruise is a luxury. If the price rises,
some people will forego it.
• Lesson: Price elasticity is higher for luxuries than for
necessities.
7. Think about this…
• The price of gasoline rises 20%. Does Qd drop more in
the short run or the long run? Why?
• There’s not much people can do in the
short run, other than ride the bus or carpool.
• In the long run, people can buy smaller cars
or live closer to work.
• Lesson: Price elasticity is higher in the
long run than the short run.
8. The Determinants of Price Elasticity:
A Summary
The price elasticity of demand depends on:
• (B) how broadly or narrowly the good is defined
• (A) the extent to which close substitutes are
available (alternatives)
• (L) whether the good is a necessity or a luxury
• (L) the time horizon—elasticity is higher in the
long run than the short run
9. Elasticity |Graphically
(a) The flatter the curve, the
bigger the elasticity (as price
rises, demand drops a lot)
(b) The steeper the curve, the
smaller the elasticity.
P
Q
P
Q
(a) (b)
The price elasticity of demand is closely related to the
slope of the demand curve.
10. Elasticity | How consumers respond to price changes
KEY POINT
How much
consumers
respond to a
price increase
depends on the
characteristics
of the good. In
particular, the 4
characteristics
in the acronym
B-A-L-L.
Test Prep Question | Do you think your price increase is likely
to scare a lot of your customers away or not? Answer this
question in the following way: (1) Describe the demand for
the website services you sell in terms of each of the
determinants of elasticity (B-A-L-L). (2) Identify whether each
determinant(s) tends to make demand elastic or inelastic. (3)
Conclude whether the demand for your product is likely to
more elastic or inelastic.
Elasticity | Part 1 10
Whenever you see a Test Prep Question, you can click on it to enter
your answers [the questions will be repeated]. After you submit your
answer, you will see the correct answer and can revise your answer to
get more practice.
The elasticity chapter in most principles textbooks is fairly technical, and is not always students’ favorite. This PowerPoint chapter contains several special features designed to engage and motivate students to learn this important material.
First, we consider a scenario in which students face a business decision—whether to raise the price of a service they sell. This scenario is used to illustrate the effects of raising price on number of units sold and on revenue, which students immediately recognize as critical to the business decision.
Second, instead of merely listing the determinants of elasticity, students are asked to think about some concrete examples and deduce from each one a lesson about the determinants of elasticity.
Third, instead of putting the applications at the end of the chapter (as in the textbook), this PowerPoint includes one of them immediately after the section on price elasticity of demand. This helps break up what would otherwise be a long stretch of theory.
Please be assured that this PowerPoint presentation is, nonetheless, very consistent with the textbook’s approach.
