Notes on Elasticity in Microeconomics

Introduction to Elasticity

• Law of Demand: Inverse relationship between price and quantity.
• Elasticity: Measures sensitivity of quantity demanded to changes in price.

Types of Elasticity

Inelastic Demand

• Definition: Quantity is insensitive to price changes.
• Example: Gasoline
  • Price increases → quantity demanded decreases slightly.
  • Price decreases → quantity demanded increases slightly.
• Characteristics:
  • Few substitutes available.
  • Necessity for consumers.
  • Elasticity coefficient: less than 1 (<1).
• Elasticity Coefficient:
  • Percent change in quantity / percent change in price.
  • When small change in quantity occurs with large price change, coefficient < 1.

Elastic Demand

• Definition: Quantity is sensitive to price changes.
• Characteristics:
  • Many substitutes available.
  • Often luxury items.
  • Elasticity coefficient: greater than 1 (>1).
• Behavior:
  • Price increases → quantity demanded decreases significantly.
  • Price decreases → quantity demanded increases significantly.

Unit Elastic Demand

• Definition: Percent change in quantity equals percent change in price.
• Example: Price increases 20% → quantity decreases 20%.
• Elasticity Coefficient: Exactly 1.

Perfectly Inelastic Demand

• Definition: Quantity remains unchanged regardless of price changes.
• Elasticity Coefficient: 0.

Perfectly Elastic Demand

• Definition: Any change in price leads to quantity demanded dropping to zero.
• Elasticity Coefficient: Infinite.

Demand Curves Overview

• Five types of demand curves based on elasticity:
  • Perfectly inelastic (coefficient = 0)
  • Relatively inelastic (coefficient < 1)
  • Unit elastic (coefficient = 1)
  • Relatively elastic (coefficient > 1)
  • Perfectly elastic (coefficient = ∞)

Total Revenue Test

• Total Revenue: Price x Quantity.
• Inelastic Demand:
  • Price increases → Total revenue increases (box grows).
  • Price decreases → Total revenue decreases.
• Elastic Demand:
  • Price increases → Total revenue decreases (box shrinks).
  • Price decreases → Total revenue increases.
• Sales Strategy:
  • Gas stations don’t have sales due to inelastic demand.
  • Products with elastic demand often have sales.

Study Tips for Total Revenue Test

• Visual aid: Use hand gestures to remember the relationship between price changes and total revenue.
  • Price up, total revenue up → look like an "I" (inelastic).
  • Price down, total revenue down → still look like an "I" (inelastic).
  • Price up, total revenue down → not an "I" (elastic).
  • Price down, total revenue up → not an "I" (elastic).

Conclusion

• Understanding elasticity is crucial for predicting consumer behavior and total revenue changes.
• Further concepts: cross-price elasticity and income elasticity.