Class Summary #29 for 11/9/11

Today's class was spent mostly on the topic of elasticity.

Elasticity, or M, = % change in Quantity Demanded
                             ____________________________
                            % change in whatever you are interested in (price)

Example: Price elasticity of demand for apples:

P-initial: $1.50/lb   Q-initial: 6 lbs of apples
P-final: $2.00/lb     Q-final: 2 lbs of apples

M apples= (2-6)/6
                 ____________ =     (2/3)/(1/3) = 2
                  (2-1.50)/1.50

Elasticity is 2---> what does this mean? It means that when the price of apples increased, our Q changes a lot, by a factor of 2 compared to the price change. Thus, our consumption behavior changes twice as fast as the price changes.

Important:


Take absolute value for Elasticity.

• If m=1, demand is "unit-elastic".
• If m<1, demand is inelastic and we can say that people are NOT very sensitive to the price change.
• If m>1, demand is elastic and we can say that people ARE very sensitive to price change.

We can define elasticity as a fact of how much consumption changes in relation to the change in price. It is the consumption w/ respect to price/other cost change. 

So, we can say elasticity is the factor by which our consumption changes compared to the price.

So, if elasticity=3.65, we can say that our demand is affected by a factor of 3.65 to the price change, since price is defined at 1.

Law of Demand: When things get more expensive, we do less of it and find alternative ways to fulfill our needs.

What Impacts Elasticity?

1. Time

2. Budget- Price changes in the goods that make up a small portion of our budget (such as salt) won't effect our consumption practices as much as goods that make up a large chunk of our budget or have a high price (such as cars). A very small change in price for a car will affect us much more than a double, triple, etc. in price of salt. I would still probably buy same amount of salt if price increased a lot because a salt costs so little already, but couldn't do this with cars since cars already cost so much. 

• Any time prices change, it has a greater effect on poor than the rich

3. Substitutes- having potential substitutes determines whether or not you can have alternatives when prices change. Usually, we adjust our behavior to price changes. A lot of this, though, depends on the availability of substitutes. This is very important. If there are not enough substitutes readily available, we may have to pay more for items we need when prices increase, which in turn will affect our budgets.

• Salt- there are not really any substitutes for salt, so does not refute the law of demand when prices go up and consumption increases because salt is such a small part of our budget and an increase in price will affect us so little, that we can afford the price increase.

The more horizontal a demand curve is, the most elastic it is. Elasticity depends on some reference point--> How much is a person consuming and how much is the current cost. Then, we can find elasticity.

On the demand curve, elasticity decreases as you move down and increases when you go up.

• Pretzel bakery- a small change in salt for them would affect them mightily (would affect us very little). Since pretzel bakeries consume so much salt, a small price change is actually a huge one for them. So, they are very sensitive to price change in salt and therefore have a large elasticity.

Consider this list:

1. minivan
2. ford minivan
3. red ford minivan

Which of the above demanded items has the highest elasticity?

To answer this question, we need to consider: time, budget and substitutes. Time and budget don't really have anything to do with the list, because they are constant or almost the same for all of those items. But we need to consider substitutes.

1. If minivan prices go up, we can get a cheaper car, bike, etc.
2. If ford minivan price goes up, can still buy a truck or other types of similar minivan. There are substitutes available.
3. Red ford minivan- if the price goes up, many many more substitutes.

The more narrowly and specific an item is, I can come up with more substitutes for the product.

Therefore, the red ford minivan is more elastic because it has the most availability of substitutes.

Then we learned about total receipt/total revenue: price x quantity or units sold = total receipt/total revenue.

Law of Demand: If prices go up, Q goes down. If prices go down, Q goes up.

Businesses always are trying to figure out the cost of raising/lowering prices on the # of consumers they will have.

If customers are sensitive to prices (elastic), a business can make more revenue when they lower prices. If customers are insensitive (inelastic), raising prices will bring more revenue.

Finally, we learned that expenditures are not the same thing as costs. Also, smaller consumption on the demand curve reflects greater elasticity generally. Greater consumption is less elastic.