Understanding Price Elasticity of Demand

Introduction

• Price Elasticity of Demand: Measure of how much the quantity demanded of a good responds to a change in price.
• Two types of demand curves:
  • Flatter demand curve: More elastic.
  • Steeper demand curve: Less elastic (inelastic).

Demand Curve Analysis

• Elastic Demand Curve:
  • Small price change leads to a large change in quantity demanded.
  • Example: Substantial quantity changes with minor price adjustments.
• Inelastic Demand Curve:
  • Quantity demanded changes minimally with price changes.
  • Even large price changes lead to small quantity adjustments.

Factors Determining Elasticity

1. Availability of Substitutes:
   • More substitutes = More elastic demand.
   • Example: Pizza (elastic) vs. Gasoline (inelastic).
2. Definition of the Market:
   • Narrower market definition = More elastic demand.
   • Example: Specific restaurant's pizza vs. pizza in general.
3. Necessity:
   • Necessities have inelastic demand.
   • Example: Life-saving medicines (inelastic) vs. app downloads (elastic).
4. Share of the Budget:
   • Larger budget share = More elastic demand.
   • Example: Minor price increases in trivial items don't affect demand.
5. Adjustment Time:
   • Longer time horizons = More elastic demand.
   • Example: Short-term vs. long-term demand response to gasoline prices.

Examples of Price Elasticity

• Cars: Elasticity slightly under 2.
• Coca-Cola: Elasticity about 1.22.
• Wine: Elasticity about 1.
• Bread: Elasticity about 0.4.
• Residential Water: Elasticity about 0.38.
• Beer vs. Residential Water: Beer is less elastic than water.
• Gasoline (Short Run): Very inelastic with elasticity close to 0.06.

Next Steps

• Upcoming topics include special cases of price elasticity and responsiveness to other variables like prices of other goods and income.