In this module, we'll look at an application of supply and demand, elasticity. The model of supply and demand helps us to understand the direction of changes in the market. Elasticity helps us to understand the sizes of those changes. For example, we know as your income rises, you buy more normal goods.
But how much more? A lot or just a little? Elasticity helps us answer that question.
We think about the term elasticity. It specifically is going to measure the responsiveness of buyers and sellers to changes in prices or income. Now, from our model of supply and demand, we already know the direction of those changes. But what we want to look at is how responsive are they?
When we think of elasticity, the root of the word being elastic. Well, what's something that's elastic? A rubber band.
Well, in your experience with rubber bands, they might be really stretchy or they might be really hard to pull apart. We can liken that type of description to supply and demand and our application here. In other words, if consumers are really stretchy, that means they're really responsive to changes. But if the rubber band is really tight, that means they don't change very much at all. In other words, a big change in your income might lead to more consumption of a normal good, but a very small change in that consumption.
In other words, we always look at this responsiveness as measured by percentage terms. One of the most important reasons we do in percent terms is so we can compare elasticity of different types of goods. For example, if we're comparing the responsiveness that consumers have for bananas to gasoline, it would be really helpful to know the perception of the consumer.
In other words, how responsive are they going to be to a 1% change in price? But a 1% change in price of one pound of bananas to a 1% change in price for a gallon of gasoline to a 1% change in price of a $30,000 car is a very different response. And so it's important to look at it in percentage terms in order to make them comparable. We're going to spend at least the beginning of this module focused on the most important elasticity application from our model of supply and demand. and that is the price elasticity of demand, specifically focused on how our quantity demand will change when there is a change in the price.
Now remember, as I've said, the law of demand is going to tell us the direction of that change. If price goes up, quantity demanded will go down. If the price goes down, quantity demanded will go up.
But the question is, how much will that quantity demanded change as a result in that change in price?