Demand Elasticities

Let's see what this looks like in the real world. Have you ever wondered why gas stations don't have sales? It has to do with substitutes and what economists call elasticity of demand. Elasticity shows how sensitive quantity is to a change in price, when the price of gas goes up people don't buy that much less gas because they need it and there are few close substitutes. Now you can walk, or ride your bike, or get an electric car but there is nothing else you can put in your current gas guzzler, this goes the other direction too, if gas stations had sales, consumers wouldn't buy that much more gas.

Economists would say that the demand for gasoline is relatively inelastic: a large percent change in price leads to a small percent change in the quantity demanded. This is shown on the graph by making the demand curve steeper, other products that have that have relatively inelastic demand include electricity, healthcare and coffee, there's no substitute for my five cups of coffee in the morning. And there are few products that have perfectly inelastic demand, if the price goes up people who can afford it will always buy the same amount, an example is insulin for diabetes because in that case they need it to live. What about the demand for pizza? Well, there are many close substitutes, I could eat a burrito or a burger, I don't really need pizza. So, a small increase in the price could cause the price to decrease a lot. For pizza the demand curve would be more flat, showing the demand for pizza is relatively elastic. If a pizza place has a sale a lot of customers would buy pizza instead of other substitutes like burgers and burritos.

Now there's also elasticity of supply. A steep curve shows the supply is relatively inelastic, so a large change in price, leads to a small change in quantity. Like an airplane is difficult and time consuming to build, so even if buyers are willing to pay more for one, they're still going to have to wait. Relatively elastic supply is when quantity is sensitive to a change in price because producers can respond quickly, stuff like t-shirts and strawberries. Something like the supply of Vincent Van Gogh paintings, well that's perfectly inelastic because when the price goes up, the quantity doesn't change. It doesn't matter if people want more, Van Gogh is not going to be doing anymore paintings

Discussion questions

1. Suppose the demand for gasoline is relatively (price) inelastic for a given price. The price of gasoline increases, say, five percent. What do you think is the effect on the quantity demanded of gasoline, holding all other variables constant? Will the quantity demanded decrease more than, less than, or equal to five percent, or no change? Will revenues increase, decrease, or stay the same after price increases? Explain your answers thoroughly. Note that revenue = price x quantity.

2. Suppose the demand for insulin is perfectly (price) inelastic for a given price. The price of insulin increases, say five percent. What do you think is the effect on the quantity demanded of insulin, holding all other variables constant? Will quantity demanded of insulin decrease more than, less than, or equal to five percent, or no change? Will revenues increase, decrease, or stay the same after price increases? Explain your answers thoroughly.

3. Suppose the demand for pizza is (price) elastic for a given price. The price of pizza increases, say, five percent. What do you think is the effect on the quantity demanded of pizza, holding all other variables constant? Will quantity demanded of pizza decrease more, less than, or equal to five percent or no change? Will revenues increase, decrease, or stay the same after price increases? Explain your answer thoroughly.