Elasticity of Demand- Micro Topic 2.3

Summary

This script delves into the concept of price elasticity of demand, illustrating how the quantity demanded reacts to price changes. It explains inelastic demand with gasoline as an example, where price fluctuations have a minimal effect due to few substitutes and necessity. The script introduces the elasticity coefficient, defining inelastic demand as having a coefficient less than one. It contrasts this with elastic demand, where quantity changes significantly with price, typically associated with products having many substitutes or being luxuries. The total revenue test is highlighted, showing how total revenue changes with price in inelastic versus elastic demand. The video concludes with a mnemonic to remember these concepts, encouraging viewers to subscribe for more economic insights.

Takeaways

• 📈 The law of demand states there's an inverse relationship between price and quantity demanded.
• 🔍 Elasticity measures the sensitivity of quantity demanded to changes in price.
• 🛢️ Gasoline has inelastic demand, meaning price changes have a small effect on quantity demanded.
• 🚫 Products with inelastic demand have few substitutes and are often necessities.
• 📏 The elasticity coefficient is calculated as the percent change in quantity divided by the percent change in price.
• 🔢 An elasticity coefficient less than one indicates inelastic demand, while greater than one indicates elastic demand.
• ⚖️ Unit elastic demand means the percent change in quantity is equal to the percent change in price, resulting in an elasticity coefficient of one.
• 📉 Perfectly inelastic demand implies no change in quantity regardless of price changes, giving an elasticity coefficient of zero.
• 📈 Perfectly elastic demand is represented by a horizontal demand curve, where any price change results in zero quantity demanded, yielding an infinite elasticity coefficient.
• 💹 The total revenue test shows that for inelastic demand, an increase in price leads to an increase in total revenue, while for elastic demand, it leads to a decrease.

Q & A

What is the inverse relationship between price and quantity?

The inverse relationship between price and quantity, as stated in the script, is that when the price of a product increases, people tend to buy less of it, and when the price decreases, people tend to buy more.

What does the term 'elasticity' refer to in the context of economics?

Elasticity in economics refers to how sensitive the quantity demanded of a product is to a change in its price. It measures the responsiveness of the quantity demanded to changes in price.

Why is gasoline considered to have inelastic demand?

Gasoline is considered to have inelastic demand because it has very few substitutes and is a necessity. As a result, even when the price increases, the quantity demanded decreases only slightly.

What is the elasticity coefficient and how is it calculated?

The elasticity coefficient is calculated as the percentage change in quantity demanded divided by the percentage change in price. It indicates whether the demand is elastic (greater than 1), inelastic (less than 1), or unit elastic (equal to 1).

What does it mean if a product has an elasticity coefficient less than one?

If a product has an elasticity coefficient less than one, it indicates inelastic demand, meaning the quantity demanded is not very sensitive to changes in price.

How does the total revenue change when the demand is inelastic and the price is increased?

When the demand is inelastic and the price is increased, the total revenue (price times quantity) increases because the quantity demanded decreases only slightly, while the price increase is significant.

What is the difference between elastic and inelastic demand in terms of total revenue?

In the case of elastic demand, when the price is increased, the total revenue decreases because the quantity demanded decreases significantly. Conversely, for inelastic demand, an increase in price leads to an increase in total revenue due to the smaller decrease in quantity demanded.

What is meant by 'unit elastic' in the context of demand?

Unit elastic refers to a situation where the percentage change in quantity demanded is equal to the percentage change in price, resulting in an elasticity coefficient of exactly one.

Can you explain the concept of 'perfectly inelastic' demand?

Perfectly inelastic demand means that there is no change in the quantity demanded regardless of changes in price. The elasticity coefficient for perfectly inelastic demand is zero.

What is the 'total revenue test' and how does it relate to elasticity?

The total revenue test is a method to determine the type of demand (elastic or inelastic) by observing the effect of price changes on total revenue. If total revenue increases when the price increases, the demand is inelastic. If total revenue decreases when the price increases, the demand is elastic.

Outlines

00:00

💡 Understanding Price Elasticity of Demand

This paragraph introduces the concept of price elasticity of demand, explaining how it measures the sensitivity of the quantity demanded of a product to changes in its price. It contrasts inelastic goods, like gasoline, where price changes have a minimal effect on quantity demanded, with elastic goods, where quantity demanded is more sensitive to price changes. The paragraph also touches on the necessity of gasoline and its lack of substitutes as reasons for its inelastic demand. The elasticity coefficient is introduced as a measure of elasticity, with values less than one indicating inelastic demand. The concept of unit elastic and perfectly inelastic demand is also briefly discussed, along with a visual representation of different demand curves to illustrate varying degrees of elasticity.

05:04

📊 The Total Revenue Test and Elasticity

The second paragraph delves into the total revenue test, which examines how total revenue changes in response to price changes for goods with inelastic and elastic demand. It explains that for inelastic demand, an increase in price leads to an increase in total revenue, while for elastic demand, an increase in price results in a decrease in total revenue. The paragraph uses a hand gesture analogy to help remember the relationship between price changes and total revenue for different types of demand. It concludes by emphasizing the importance of understanding elasticity for predicting changes in total revenue and encourages viewers to watch further videos on related economic concepts.

Keywords

💡Elasticity

Elasticity in economics refers to the measure of how sensitive the quantity demanded or supplied of a product is to a change in price. It is a crucial concept in the video as it explains how changes in price affect consumer behavior. For instance, the video discusses gasoline as having inelastic demand, meaning that even if the price increases, the quantity demanded does not decrease significantly, illustrating the concept's practical application.

💡Inelastic Demand

Inelastic demand describes a situation where the quantity demanded of a good does not change significantly in response to price changes. The video uses gasoline as an example, explaining that because it has few substitutes and is a necessity, its demand is inelastic. This concept is important for understanding why certain products, like gasoline, do not see drastic changes in sales volumes with price fluctuations.

💡Price and Quantity Relationship

The relationship between price and quantity is a fundamental economic principle stating that as the price of a product increases, the quantity demanded typically decreases, and vice versa. This inverse relationship is central to the video's discussion on elasticity, as it sets the stage for explaining how different products react to price changes with varying sensitivities.

💡Substitutes

Substitutes are products that can be used in place of one another. The video explains that products with inelastic demand, like gasoline, have very few substitutes, which contributes to their inelasticity. The concept is essential for understanding why some products are less sensitive to price changes than others.

💡Elasticity Coefficient

The elasticity coefficient is a mathematical representation of elasticity, calculated as the percentage change in quantity demanded divided by the percentage change in price. The video clarifies that a coefficient less than one indicates inelastic demand, while a coefficient greater than one indicates elastic demand. This coefficient is central to quantifying the degree of elasticity.

💡Necessity

A necessity is a product that is essential for consumers, regardless of price. The video mentions that gasoline is considered a necessity, which contributes to its inelastic demand. Understanding the concept of necessity helps to explain why certain products do not experience significant changes in quantity demanded with price changes.

💡Total Revenue Test

The total revenue test is a method to determine the type of elasticity by observing how total revenue changes in response to price changes. The video explains that if total revenue increases when price increases, the demand is inelastic, and if total revenue decreases when price increases, the demand is elastic. This test is a practical application of elasticity concepts in business and economics.

💡Unit Elastic

Unit elastic demand occurs when the percentage change in quantity demanded is equal to the percentage change in price, resulting in an elasticity coefficient of exactly one. The video uses this concept to illustrate a scenario where a price increase leads to an equal proportional decrease in quantity demanded, maintaining the total revenue constant.

💡Perfectly Inelastic

Perfectly inelastic demand implies that the quantity demanded does not change at all, regardless of price changes. The video mentions this concept in the context of a vertical demand curve, where the elasticity coefficient is zero, indicating that price changes have no effect on quantity demanded.

💡Perfectly Elastic

Perfectly elastic demand is a theoretical concept where even a small change in price leads to an infinite change in quantity demanded. The video briefly touches on this by describing a horizontal demand curve, where any price change results in no quantity being demanded, and the elasticity coefficient is infinite.

Highlights

Elasticity measures the sensitivity of quantity demanded to changes in price.

Inelastic demand means a small change in quantity when the price changes, as seen with gasoline.

Products with inelastic demand have few substitutes and are often necessities.

The elasticity coefficient is calculated as the percentage change in quantity divided by the percentage change in price.

An elasticity coefficient less than one indicates inelastic demand.

Elastic demand is when quantity is very sensitive to price changes, often with many substitutes or luxury goods.

An elasticity coefficient greater than one signifies elastic demand.

Unit elastic demand occurs when the percentage change in quantity equals the percentage change in price, resulting in an elasticity coefficient of one.

Perfectly inelastic demand means no change in quantity regardless of price changes, with an elasticity coefficient of zero.

A horizontal demand curve indicates perfectly elastic demand, where price changes have no effect on quantity, leading to an infinite elasticity coefficient.

The total revenue test shows the impact of price changes on total revenue, differing between inelastic and elastic demand.

For inelastic demand, an increase in price leads to an increase in total revenue, as seen with gas stations not having sales.

Elastic demand results in a decrease in total revenue when the price increases, which is why sales are common for such products.

A mnemonic for the total revenue test is using the shape of the letter 'I' to remember inelastic demand scenarios.

The video also covers cross-price and income elasticity in subsequent content.

The presenter uses humor and personal anecdotes to make the topic of elasticity more relatable and engaging.

Transcripts

Hey,

you already know the law demands says there's an inverse relationship between price and quantity

So the price goes up for a product people buy less the price goes down people buy more

but the question now is how much less or how much more they buy and that's the idea of elasticity

Elasticity shows how sensitive quantity is to a change in price what happens to quantity when there's a change in price depends a lot on

the type of product first we are gonna talk about the idea of

inelastic let's talk about Gasoline gasoline has inelastic demand this means when there's an increase in the price of gasoline

the quantity demanded decreases, but just a little bit

So when the demand is inelastic the quantity is insensitive to a change in price

And it goes the other direction when the price falls the quantity demanded goes up

But just a little bit. Right, you don't jump in your car when the price goes down and grab your engine

At stop signs that's not what you do

So when the price goes down you buy a little bit more when the price goes up you buy a little bit less

insensitive to a change in price. the reason for this is because

Products that have an inelastic demand have very few substitutes. When it comes to gasoline. There's nothing else

I can put my car and God knows, I'm not walking

I'm American. That was a joke to all you guys who are environmentalist. I apologize. I don't want to hurt your feelings

I love trees. I will hug one. I love you.

I love you so much

In addition to having few substitutes gasoline is also a necessity, and it has elasticity coefficient that is less than one (<1)

whoa coefficient! no math! can't stand math! listen,

There's Gonna be a little bit of math in microeconomics

But it's nothing crazy. One of the things you got to watch out for is freaking out when you hear things like coefficient

It's not that hard. The elasticity of demand coefficient is the percent change in quantity,

divided by the percent change in price

Which is not hard at all is trying to say is that when there's a small

Change in quantity when there's a big change in price, this number is less than 1 and if it's less than 1 its inelastic demand

Real quick, we're talking about absolute value remember when the price goes up the quantity always goes down

so we're talking about the absolute value of the elasticity of demand coefficient. The point is when there's an inelastic demand the

Quantity is insensitive to a change in price. So what if demand is elastic?

that means quantity is sensitive to a change in price, so right here when the price goes up

the quantity decreases a whole lot, and when the price goes down the quantity demand goes up a whole lot

So when the demand is elastic it means that these products have many substitutes

Or they're luxuries, or they have elasticity coefficient

Greater than one (>1) a big change in quantity as a result of a small change in price

now, what if the percent change in quantity is exactly equal to percent change in price?

Well that's something called unit elastic. unit elastic is the idea if the price goes up 20 percent, then the quantity goes down 20 percent

this pops out a 1. A 1 means unit elastic

What if the demand is a vertical straight line or something called perfectly inelastic?

well that means an

Increase in price has no effect on quantity. the quantity doesn't change so the percent change in quantity is zero whenever there's a percent change in price

And so the elasticity demand coefficient is zero

That's the idea perfectly inelastic

And if the demand curve is horizontal

Where a firm cannot change the price at all. they change the price no one's going to buy that would mean that the elasticity demand

Coefficient would be infinite. all this will make more sense when you see them side by side

So take a look at this. what you're looking at is five different demand curves perfectly inelastic,

relatively inelastic, unit elastic, relatively elastic and perfectly elastic and you can see the

elasticity coefficient is zero,

Less than one, one, greater than one and infinite. this shows you

the more substitutes a product has, the more sensitive it is to a change in price, the greater the elasticity demand coefficient

Does it make sense? bonus round!

One of the most important topics you're going to see is something called the total revenue test

So this tells you what happens to total revenue when there's a change in price if the demand curve is inelastic or elastic

It'll make more sense on a graph over here on the left

We have inelastic demand. Right here on the right,

We have elastic demand. the total revenue is the price times the quantity it's this box right here

Notice how the box on both graphs starts exactly the same size. when supply shifts to the left

that causes the price to go up. notice that on both curves the price goes up and the

Quantity goes down. remember, the law of demand is at play here. when the price goes up the quantity goes down

We're not analyzing that but we're analyzing is the total revenue

The size of the box. so for inelastic demand the price went up a whole lot, but quantity decrease

Just a little bit and so the size of the box got bigger that means when the demand

is inelastic the price goes up the total revenue goes up

or when the price goes down the total revenue goes down and that explains why gas stations never have sales

Right, there's no reason for a gas station to have like a half off gas sale

Because they lower their price the total revenue is not going to increase

But let's take a look at elastic demand

When the price goes up a whole lot of people don't want to buy it and so the size of the total revenue box gets

Smaller so when the price goes up total revenue falls and when the price goes down, total revenue goes up

That's why products that have

elastic demand will have sales all the time. now what you're going to see on a test is a question that says if there's a

Given product, Product X, and the price goes up and the total revenue goes down

What must be true? The answer is it's elastic demand. right, if the price goes up and the total revenue, the box gets smaller,

That's elastic demand

Bonus bonus round!! one of the things I do to help students understand the total revenue test is given this thing to do with their hands

so if the price goes up for product and the total revenue goes up, I look like an "I"

I look like an "I" the demand is "I"nelastic

right, price goes up total revenue goes up

The other way to look like an "I" is when the price goes down and total revenue goes down. I look like an "I"

I'm "I"nelastic demand. if the price goes up and total Revenue goes down. I don't look like an "I".

I'm elastic demand. if price goes down and total revenue goes up

I'm not an "I" it must be elastic demand

So this is going to help you on a test if they say the price goes up for a product and the total revenue went

up, you look at yourself. You look like an "I", inelastic demand. I hope this video helped you understand

the idea of elasticity and the total revenue test. And make sure to subscribe

And take a look at the next video that explain cross price and income elasticity. Also, check out my series of videos called

Econ Movies, alright? Till next time!

ENG CC By: Tammie Ng Lin Ern