Price Elasticity of Demand Lecture by Jacob Reed

Overview

• Price Elasticity of Demand: Measures how much the quantity demanded of a good responds to changes in the price of that good.
• Concept: Understanding consumer sensitivity to price changes.
• Resource: ReviewEcon.com and the Total Review Booklet for further study.

Key Concepts

Definition

• Price Elasticity: Degree to which the quantity demanded of a good changes as its price changes.
• Price Increase: Quantity demanded decreases.
• Price Decrease: Quantity demanded increases.

Determinants of Price Elasticity of Demand

1. Necessity vs. Luxury

   • Inelastic Demand: Necessities (e.g., life-saving drugs) – Consumers are less sensitive to price changes.
   • Elastic Demand: Non-necessities (e.g., cookies) – Consumers are more sensitive to price changes.

2. Availability of Substitutes

   • Inelastic Demand: Few substitutes (e.g., heart transplants) – Less sensitive to price changes.
   • Elastic Demand: Many substitutes (e.g., cola) – More sensitive to price changes.

3. Proportion of Income

   • Inelastic Demand: Cheap goods (e.g., pencils) – Less sensitive to price changes.
   • Elastic Demand: Expensive goods (e.g., cars) – More sensitive to price changes.

4. Demand Curve Shape

   • More Vertical: Inelastic – Large price changes cause small changes in quantity demanded.
   • More Horizontal: Elastic – Small price changes cause large changes in quantity demanded.

5. Total Revenue Test

   • Formula: Total Revenue = Price × Quantity Sold.
   • Elastic Demand: Price increase leads to total revenue decrease (opposite directions).
   • Inelastic Demand: Price increase leads to total revenue increase (same direction).
   • Unit Elastic: Total revenue remains unchanged with price changes.

6. Elasticity Coefficient

   • Formula: Percentage change in quantity demanded / Percentage change in price.
   • Interpretation: Absolute value > 1 (Elastic), = 1 (Unit Elastic), < 1 (Inelastic).

Price Elasticity Tests and Examples

• Elastic: Price elasticity coefficient > 1 (e.g., 30% price increase, 60% demand decrease → Elastic).
• Inelastic: Price elasticity coefficient < 1 (e.g., 20% price increase, 10% demand decrease → Inelastic).
• Unit Elastic: Price elasticity coefficient = 1 (e.g., 25% price increase, 25% demand decrease → Unit Elastic).

Calculation Methods

1. Endpoint Formula:

   • Formula: (New - Old) / Old × 100.
   • Example: Price changes from $20 to $24, quantity from 200 to 180.

2. Midpoint Formula (Not preferred for AP Exams):

   • Formula: (New - Old) / ((New + Old) / 2) × 100.

Extremes in Elasticity Coefficients

• Perfectly Elastic: Horizontal demand curve – Any price increase drops demand to zero. Elasticity coefficient = infinity.
• Perfectly Inelastic: Vertical demand curve – Demand unchanged irrespective of price change. Elasticity coefficient = zero.

Additional Resources

• Elasticity Coefficients Game: Available for practice.
• Further Study: Watch other elasticity videos and visit ReviewEcon.com for more resources.