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In this module, we are going to first turn to
the three main ways to categorize demand elasticity.
Elastic, unit elastic, and inelastic.
The various slow patterns
associated with these three categories are drawn in this figure,
with the relatively flat slow pattern of elastic demand at the top left,
the unit elastic demand pattern at the top right,
and the steeply sloped inelastic demand pattern in the bottom center.
And here, let me ask you this,
do these patterns make intuitive sense to you based on what you learned
thus far about elasticities?
Now, let's take each of these categories one at a time,
starting with a relatively flat slope elastic demand.
As a key definition,
demand is elastic if a given percentage change in
price results in a larger percentage change in quantity demanded.
For example, if a 2% fall in price results in a 4% change in quantity demanded,
the elasticity is greater than 1.
Note too, there is a special case that economists call perfectly elastic demand,
in which elasticity spins off into infinity.
In this case, any percentage increase in price would
result in the total elimination of demand for the product.
So what do you think the slope of a perfectly elastic demand curve would look like?
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That's right, it will look like this.
The demand curve would be horizontal.
Now, take a look at this figure depicting inelastic demand.
In this key definition,
demand is inelastic if the price elasticity is less than one.
For example, if a 3% decline in price leads to
just a 1% increase in quantity demanded, demand is inelastic.
As you can see in this case,
the percentage change in price is accompanied by
a relatively smaller change in the quantity demanded.
Note that the curve is steep as in our cigarettes example.
And note here too, that if the demand curve were perfectly vertical,
demand would be said to be perfectly inelastic.
Finally, there's a very interesting case of unit elasticity.
In this key definition,
demand is said to be unit elastic if the price plasticity equals one.
For example, if a 1% drop in price causes a 1% increase in quantity demanded,
elasticity is exactly one or unity.
As to why we care about the differences between inelastic,
unit elastic, and elastic demand from a business and marketing perspective,
I will explain that soon.
But for now, we need to finish up this module with a quick look at
the key determinants of the price elasticity of demand.
As a preview of this discussion,
take a look at this table and on a piece of paper or on your computer tablet,
put a single check mark beside any good listed that
you think might be characterized by inelastic demand,
and put two check marks besides products you think might have elastic demand.
Pause the presentation now,
please give this exercise a spin.
Okay, here's the table
with the actual numerical elasticities.
Note that necessities like housing,
electricity, and bread are very price inelastic.
Did you put a single check mark besides each of these?
On the other hand, goods that tend more towards being luxuries like new cars,
restaurant meals, and fine glassware,
are very pricey elastic.
Did you put double check marks besides these?
Now, from what we've just learned from our table of elasticities list,
we can generalize to the major determinants of price elasticity.
Our complete list includes luxuries versus necessities,
substitutability, product definition, proportion of income, and time.
While we already know that luxury goods will have higher elasticities than necessities,
the key rule for product substitutability is this,
the greater the number of substitutes for a good,
the more elastic it's demand will be.
For example, beef has a lot of substitutes, poultry,
fish, pork, even soy burgers, I personally like here.
In contrast, cigarettes have little or no substitutes.
That's why a cigarette addict's demand is much more
inelastic than the beef eater's as we saw in our earlier example.
Now, what about product definition?
The key idea here is that the elasticity of
demand also depends on how narrowly the product is defined.
For example, what do you think has a more elastic demand,
branded gasoline like Chevron BP or Shell or gasoline in general?
Think carefully about this.
It's an interesting puzzle.
Is the more narrowly defined product, a branded gasoline,
or gasoline in general going to
be more price elastic?
That's right. The demand for branded gas is much
more elastic than the demand for gas in general.
This is because each of the various brands can easily be substituted for the other.
However, there are no real good substitutes yet for gasoline in general.
Now, a third determinant of demand price elasticity is the proportion
of income used to buy a given product. Here's the key rule.
The higher the price of a good relative to your budget,
the greater will be your elasticity of demand for it.
For example, a 10% increase in the price of pencils will amount to
only a few pennies with little response in the amount you demand.
In contrast, a 10% increase in the price of housing
would have a significant impact on the quantity demanded in the marketplace.
As our fourth and final determinant of demand elasticities,
there is the factor of time.
The key rule here is this.
In general, demand will tend to be more elastic in the long run than in the short run.
The case in point is offered by the severe electricity crisis
the state of California in the United States experienced at the turn of the century.
Despite soaring prices, consumers did little to cut their consumption,
indicating a very inelastic demand for
the electricity they needed to keep their home cool,
their food warm, and their lights and computers on.
However, over time in California many homeowners invested in
solar power technologies to help them get off the electricity grid.
Demand elasticity across the population has increased.
Dr. Peter NavarroProfessor
