Elastic demand the type of demand that exists when

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Unformatted text preview: asticity of demand The relationship between the percentage change in quantity demanded and the percentage change in price. elastic demand The type of demand that exists when the percentage change in quantity demanded is greater than the percentage change in price. 102 Chapter 4 Demand Suppose Jimmy loves chewing gum, so much so that he buys as many as four or five packs a week. One day he notices that the price of his favorite gum has gone up a quarter. Jimmy will probably now buy less chewing gum. But how much less? This question about Jimmy’s gum buying is the kind of question that you will learn how to answer as you study our next economic concept, elasticity of demand. Elasticity of demand deals with the relationship between price and quantity demanded. It is a way of measuring the impact that a price change has on the number of units of a good people buy. In some cases a small price change causes a major change in the number of units of a good people buy. In other cases, a small price change causes little change in how many units of a good people buy. Elastic Demand Economists have created a way to measure these relationships between price and quantity demanded. They compare the percentage change in quantity demanded of a good to the percentage change in the price of that good. In mathematical terms, here is what elasticity of demand looks like: Elasticity of demand Percentage change in quantity demanded Percentage change in price In the equation, the numerator is percentage change in quantity demanded, and the denominator is percentage change in price. Elastic demand exists when the quantity demanded (the numerator) changes by a greater percentage than price (the denominator). For example, suppose the quantity demanded of lightbulbs falls by 15 percent as the price of lightbulbs increases by 10 percent. An economist would say that because the numerator (15%) is greater than the denominator (10%), the demand for lightbulbs is elastic. Another way that an economist might say it is that elasticity of demand is greater than 1, because if you divide 15 percent by 10 percent, you get 1.5, which is greater than 1. 04 (086-109) EMC Chap 04 11/17/05 4:37 PM Page 103 Inelastic Demand Inelastic demand exists when the quantity demanded changes by a smaller percentage than price—that is, when the numerator changes by less than the denominator. Suppose the quantity demanded of salt falls by 5 percent as the price of salt rises by 10 percent. In this case the numerator (5%) is less than the denominator (10%), so the demand for salt is inelastic. An economist could say that elasticity of demand is less than 1 (if you divide 5% by 10% you get 0.5, which is less than 1). EXHIBIT 4-5 Elasticity of Demand If demand is . . . That means . . . Elastic Quantity demanded changes by a larger percentage than price. For example, if price rises by 10 percent, quantity demanded falls by, say, 15 percent. Inelastic Quantity demanded changes by a smaller percentage than price. For example, if price rises by 10 percent, quantity demanded falls by, say, 5 percent. Unit-elastic Quantity demanded changes by the same percentage as price. For example, if price rises by 10 percent, quantity demanded falls by 10 percent. Unit-Elastic Demand Finally, unit-elastic demand exists when the quantity demanded changes by the same percentage as price—that is, when the numerator changes by the same percentage as the denominator. For example, suppose the quantity demanded of picture frames decreases by 10 percent as the price of picture frames rises by 10 percent. The numerator (10%) is equal to the denominator (10%), so the demand for picture frames is unit elastic. According to an economist, elasticity of demand would be equal to 1 (10% divided by 10% equals 1). When elasticity of demand is greater than 1, we say that demand is elastic. When it is less than 1, we say that demand is inelastic. And finally, when it is equal to 1, we say that demand is unit-elastic. See Exhibit 4-5. Elastic or Inelastic? So, you’re probably wondering what products are elastic and which ones are inelastic? One economics study identified oysters, restaurant meals, and automobiles as goods with elastic demand. For these goods, price changes have a strong impact on how much customers will buy. In the same study, coffee, gasoline (for your car), physicians’ services, and legal services were identified as goods with inelastic demand. For these products a change in price had less impact on how much customers will buy. E X A M P L E : A university raises its tuition by 10 percent. As a result, the number of students applying to the university falls by 2 percent. In this situation, we would say that the demand for education at this particular university is inelastic. Why? Because the percentage change in quantity demanded (2%) is less than the percentage change in price (10%). What Determines Elasticity of Demand? The demand for some goods (coffee, gasoline at the local gas station, physic...
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