Handout 10-2 AELASTICITY OF DEMAND AND CHANGES IN TOTAL REVENUE Name Class What exactly do we mean by "a considerable 2 Price falls from $10 to $9. Quantity demanded change" and "a little change" in the quantity demanded? .increases from 100 to 110. One way to define elasticity of demand more precisely is to examine what happens to total revenue when a a Old price x quantity demanded = old total reve price changes. Total revenue is price times quantity demanded. b New price x. quantity demanded = new total reve Price x quantity demanded = total revenue $10 X 150 items $1,500 . What happens to total revenue depends on the CPIT TRI relative size of the changes in price and the quantity 3 Price rises from $6 to $9. Quantity demanded demanded. If the percentage change in the quantity decreases from 60 to 50. demanded is greater than the percentage change in price, total revenue and the price change will move in a Old price x quantity demanded = old total rever opposite directions. This situation indicates that the de- mano schedule that lies between the two prices is elas- tic. If the percentage change in quantity demanded is b New price x quantity demanded = new total reve less than the percentage change in price, total revenue and the price change will move in the same direction. This situation indicates that the demand schedule that CPIT TRI lies between these two prices is inelastic. Let's sum- marize these points: 4 Price falls from $6.50 to $6.00. Quantity de- manded increases from 100 to 200. Price 1 Total revenue 1 = a Old price x quantity demanded = old total revel Elastic demand Price | Total revenue 1 = b New price x quantity demanded = new total reve Price 1 Total revenue 1 = Inelastic demand Price | Total revenue ! = C PI T TRI Instructions: Now let's do some problems to drive 5 Price falls from $4.00 to $3.75. Quantity de- home the point. For each problem, complete the manded increases from 300 to 340. math and circle the correct answer. Then write whether the product has an elastic or inelastic de- a Old price x quantity demanded = old total revel mand schedule between these two prices. The first problem is completed for you. b New price x quantity demanded = new total reve 1 Price rises from $5 to $6. Quantity demanded decreases from 15 to 10. a Old price x. quantity demanded = old total revenue C TR 1 5 15 75 5 Why do price and total revenue go in opposite b New price x quantity demanded = new total revenue directions when the demand for the good is elastic? 6 10 60 7 Why do price and total revenue go in the same C PI 1 TR 1 elastic direction when the demand for the product is inelastic?Handout 10-1 WHAT IS PRICE ELASTICITY OF DEMAND? Name Class You have learned that when price changes, the demanded responds relatively little to changes in price. quantity demanded changes. An increase in price causes a decrease in the quantity demanded. A de- Several factors can determine if a product has an crease in price causes an increase in the quantity de- elastic or an inelastic demand schedule. manded. Necessities tend to have an inelastic demand. Peo- However, it's not enough to know that the quantity ple find it hard to give up a necessity because they demanded rises or falls in response to price changes. cannot readily buy less of it when its price rises. Lux- It is also important to know by how much the quantity uries tend to have an elastic demand. People can get demanded changes. A business may decide not to in- along without them if the price becomes too high. crease the price of a product if people will buy much Products that have many substitutes tend to have less of it at the higher price. Or, a business may decide an elastic demand because it is easy to buy a substitute to increase the price of a product if people will buy only if the price of one product in the group of substitutes a little less of it at the higher price. rises too much. A product that has few substitutes tends How much the quantity demanded changes in re- to have an inelastic demand. Buyers don't have much sponse to price changes is called the price elasticity choice if there are few substitutes, so they think twice of demand. If the quantity demanded changes con- before giving up such a product when its price rises. siderably, the good or service has an elastic demand. Goods and services that take a large portion of a Elastic demand means the quantity demanded is very purchaser's budget tend to have an elastic demand responsive to changes in price. If the quantity de- schedule. Those that consume a small portion of a manded changes little, the good or service has an in- purchaser's budget tend to have an inelastic demand elastic demand. Inelastic demand means the quantity schedule. INSTRUCTIONS: Determine whether the demand for the following items is price elastic or inelastic. Write your answer on the line after the item. Then write the reasons for your answer. Salt Why? 2 New cars Why? 3 Pork chops Why? 4 European vacation trip Why? 5 Insulin . Why? 6 Insulin at one of four drug stores in Why? a shopping mall