Elasticity of Demand

Elasticity
-Elasticity: a measure of how consumers react to a change in price

• There are 3 types of Elasticity:

                  1) Elastic Demand: Demand that is very sensitive to a change in price
                        -There are substitutes
                        -Considered luxury goods
                               *Ex. Cars, Sodas, Meat
                         -When calculated their value is Greater than 1 (>1)
                  2) Inelastic Demand: Demand that is not very sensitive to change in price
                         -They have few substitutes
                         -They are a necessity
                               *Ex. Gas, Insulin, Salt, Milk, Water
                         -When calculated their value is Less than 1 (<1)
                  3) Unitary Elastic: Equal to 1 (=1)


Steps to Find Price Elasticity of Demand (PED)
-Step 1:▲ in Quantity

• (new - old) / old

-Step 2:▲ in Price

• (new - old) / old

-Step 3: PED

• (▲ in Quantity) / (▲ in Price) = Price Elasticity of Demand

              * Note: If your final answer is negative, place your answer in absolute value bars ( |  | ).

Example Problems

Example 1
 Yesterday, the price of envelopes was $3 a box, and Julie was willing to buy 10 boxes. Today, the price has gone up to $3.75 a box, and Julie is now willing to buy 8 boxes. Is Julies's demand for envelops elastic or inelastic? What is Julie's elasticity of demand?
            -Step 1:▲ in Quantity
                         (8 - 10) / 10 = -.20
            -Step 2:▲  in Price
                         (3.75 -3) / 3 = .25
            -Step 3:▲PED
                         (-.20) / (.25) = -.8 = |.8|
ANSWER: Julie's elasticity of demand is .8 and the elasticity of demand  is inelastic because it's less than 1 (<1)

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Example 2
 Which of the following goods are likely to have elastic demand, and which are likely to have inelastic demand?
       Home heating oil
       Pepsi
       Chocolate
       Water
       Heart medication
       Oriental rugs
ANSWER: Elastic demand- Pepsi, Chocolate, and Oriental rugs
            Inelastic demand- Home heating oil, water, and heart                                                 medication
          *Note: if you need assistance refer back to Elasticity Sub-heading

For More Examples visit the link below:

http://www.sparknotes.com/economics/micro/elasticity/problems.html