Richard Damra Monday, January 28, 2013
Econ 1B03 – Chapter 5 – Elasticity Part 2
Generalities About Elasticities and Their Determinants
1. Goods that are necessities tend to have inelastic demand.
o E.g demand for insulin – perfectly inelastic
o E.g demand for dentist visits – inelastic
2. Goods that are luxuries tend to have elastic demand
o E.g plasma TV or vacations – elastic
3. Goods that have close substitutes tend to have elastic demand.
o E.g Coke and Pepsi (if Price of Coke increase, switch to Pepsi fairly quickly)
o E.g eggs have no close substitutes – inelastic
4. Goods tend to have more elastic demand over longer time horizons
o You can find substitutes in the long run where you can’t today
5. How you define the market makes a difference
o E.g market for food – perfectly inelastic.
o Market for vegetables – more elastic
o Market for broccoli – even more substitutes so even more elastic
o The more narrowly defined the market, the more elastic the demand.
6. How much of your budget you spend on a good determines elasticity.
o If you spend a large proportion of your budget on a good, demand for that good will
tend to be elastic.
o If you only spend a small proportion, demand will tend to be inelastic.
Elasticity is not constant along a linear demand curve
Elasticity is not the same as slope.
Slope measures rates of change.
Elasticity measures percentage changes.
We can illustrate different elasticities along the demand curve
o Midpoint = unit elastic Richard Damra Monday, January 28, 2013
Why does elasticity change along the curve the way it does?
Recall that our point elasticity formula for a demand curve specified as Q = f(p) is Ep = dQ/dP *
Slope dQ/dP is constant for a linear demand curve
But P and Q are different combinations at different points on the demand curve, so elasticity
changes along the demand curve.
Since dQ/dP is the slope of the demand curve, that’s why we can see elasticity by the steepness
(slope) of the curve.
Price Elasticity and Total Revenue
A firm wants to maximize its profit. Other things being equal, it will want to maximize its total
The firm would like to sell as much as it could at the highest price it could get. But, it wouldn’t
want to charge a price so high that it loses costumers and revenue drops.
Here’s where knowing the price elasticity of demand for its good is hand for a firm.
Total revenue, TR, is defined as TR = PQ (Price times the quantity traded)
With an inelastic demand curve, an inc