Lecture Notes: Understanding Elasticity in Economics

Key Concepts

• Law of Demand: There is an inverse relationship between price and quantity demanded.

  • Price increases lead to decreased quantity demanded.
  • Price decreases lead to increased quantity demanded.

• Elasticity: Measures how sensitive quantity demanded is to a change in price.

Types of Demand Elasticity

1. Inelastic Demand

   • Characteristics:
     • Quantity demanded is insensitive to price changes.
     • Few substitutes available.
     • Necessity goods (e.g., gasoline).
     • Coefficient of elasticity < 1.
   • Example: Gasoline
     • Price increases lead to a slight decrease in quantity demanded.
     • Price decreases lead to a slight increase in quantity demanded.

2. Elastic Demand

   • Characteristics:
     • Quantity demanded is sensitive to price changes.
     • Many substitutes available or luxury goods.
     • Coefficient of elasticity > 1.
   • Behavior:
     • Large change in quantity demanded with small price changes.

3. Unit Elastic Demand

   • Definition: Percent change in quantity equals percent change in price.
   • Coefficient: Equal to 1.

4. Perfectly Inelastic Demand

   • Characteristics:
     • No change in quantity demanded regardless of price changes.
     • Coefficient of elasticity is 0.

5. Perfectly Elastic Demand

   • Characteristics:
     • Firm cannot change the price; quantity demanded changes infinitely.
     • Coefficient of elasticity is infinite.

Visualizing Demand Curves

• Demand curves show different elasticity types.
  • Perfectly Inelastic: Vertical line, coefficient = 0.
  • Relatively Inelastic: Coefficient < 1.
  • Unit Elastic: Coefficient = 1.
  • Relatively Elastic: Coefficient > 1.
  • Perfectly Elastic: Horizontal line, coefficient = infinity.

Total Revenue Test

• Purpose: Understanding the effect of price changes on total revenue.
• Calculating Total Revenue: Price x Quantity = Total Revenue

Inelastic Demand

• Price Increase:
  • Quantity decreases slightly.
  • Total revenue increases.
• Price Decrease:
  • Total revenue decreases.

Elastic Demand

• Price Increase:
  • Quantity decreases significantly.
  • Total revenue decreases.
• Price Decrease:
  • Total revenue increases.

Exam Tips

• Recognize demand type based on price and total revenue changes.
• Use hand signals for self-check:
  • Price & revenue both increase or decrease = "I" shape = Inelastic.
  • Price & revenue move in opposite directions = Elastic.

Conclusion

• Understanding elasticity is crucial for interpreting consumer behavior and making business decisions.
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