Chapter 4:3: DEFINING DEMAND:

Chapter 4:3: DEFINING DEMAND:

Objectives: Analyze the concepts of the law of demand. Explain how the substitution effect and income effect affect decisions.

Gen_32:26 And he said, Let me go, for the day breaketh. And he said, I will not let thee go, except thou bless me.

Elasticity of Demand Economists describes the way that consumers respond to price changes as elasticity of demand. Elasticity of demand measures how drastically buyers will cut back or increase their demand for a good when the price rises or falls, respectively. If you buy the same amount or just a little less of a good after a large price increase, your demand is inelastic, or relatively unresponsive to price changes.

Elasticity of Demand If you buy less of a good after a small price increase, your demand is elastic. A consumer with highly elastic demand for a good is very responsible to price changes.

Calculating Elasticity In order to calculate elasticity of demand, take the percentage of change in the quantity of the good demanded and divide this number by the percentage change in the price of the good. The result is the elasticity of demand for the good.

Calculating Elasticity The law of demand implies that the result will always be negative. That is because an increase in the price of a good will always decrease the quantity demanded, and a decrease in the price of a good will always increase the quantity demanded.

Price Range The elasticity for demand for a good varies at every price level. Demand for a good can be highly elastic at one price and inelastic at a different price.

Values of Elasticity. We have been using the terms inelastic and elastic to describe consumers responses to price changes. These terms have precise mathematical definitions. If the elasticity of demand for a good at a certain price is less than 1, we describe demand as inelastic. If the elasticity is greater than one demand is elastic. If elasticity is exactly equal to 1, we describe as unitary elastic. Equation page 98-99.

Factors Affecting Elasticity: Why is the demand for some goods so much less elastic than for other goods? Rephrase the question and ask yourself, What is essential to me? What goods must I have, even if the price rises greatly? The goods you list might have some traits that set them apart from other goods and make our demand for those goods less elastic. Several different factors can affect a person s elasticity of demand for a specific good.

Factors Affecting Elasticity: AVAILABILITY of SUBSTITUTES: If there are few substitutes for a good, then even when its price rises greatly, you might still buy it. You believe you have no good alternatives.

Factors Affecting Elasticity: HYPOTHETICAL: if your favorite musical group plans to give a concert, that you want to attend, there really is no substitute for that ticket. You would go to a concert to hear some other band, but that would not be as good. You ve got to have tickets for this concert, and nothing else will do. Under these circumstances a moderate change in price is not going to change your mind. What is your demand?

Factors Affecting Elasticity: Similarly, demand for life-saving medicine is usually inelastic. If the lack of substitutes can make demand inelastic, a wide choice of substitute goods can make demand elastic. Examples: brand of apple juice. Sodas, Chips, etc.

Relative Importance: A second factor in determining a good s elasticity of demand is how much of your budget you spend on the good. If you already spend a large share of your income on a good, a price increase will force you to make some tough choices.

Relative Importance: Unless you want to cut back drastically on the other goods in your budget, you must reduce consumption of that particular good by a significant amount to keep your budget under control. The higher the jump in price, the more you will have to adjust your purchases.

Relative Importance: o If you currently spend half of your budget on clothes, even a modest increase in the cost of clothing will probably cause a large reduction in the quantity you purchase. o Your demand will be elastic. o If the price of shoe laces doubled, would you cut back on your shoe lace purchases? o Probably not.

Necessities versus Luxuries: The third factor in a good s elasticity varies a great deal from person to person but it is important. Whether a person considers a good to be a necessity or a luxury has a great impact on a person s elasticity of demand for that good. A necessity is a good people will always buy, even when the price increases. Parents often regard milk as necessity but steak as a luxury.

Change Over Time: When a price changes, consumers often need time to change their spending habits. Consumers do not always react quickly to price increase, because it takes time to find substitutes. Because they cannot respond quickly to price changes, their demand is inelastic in the short term. Demand sometimes become more elastic over time, however because people can eventually find substitutes.

Change Over Time: Consider gasoline, a person might purchase a large vehicle that requires a greater volume of gasoline per mile to run. This person might work at a job many miles away from home and shop at a supermarket that is not local. These factors determined how much gasoline this person demands and one can be changed easily.

Elasticity and Revenue: Elasticity is important to the study of economics, because elasticity helps us measure how consumers respond to price changes for different products. Elasticity of demand determines how a change in prices will affect a firm s total revenue, or income.

Computing a Firm s Total Revenue: A company s total revenue is defined as the amount of money the company receives by selling its good. This is determined by two factors: The price of the goods, and the quantity sold.

Total Revenue and Elastic Demand: The law of demand tells us that an increase in price will decrease the quantity demanded. When a good has an elastic demand, raising the price of each unit sold by 20 percent will decrease the quantity sold by a large percentage.

Total Revenue and Elastic Demand: The same process can also work in reverse. If the firm were to reduce the price by a certain percentage, the quantity demanded could rise by an even greater percentage. In this case, total revenues could rise.

The elasticity of demand has these following factors: o The availability of substitute goods. o A limited budget that does not allow for price changes. o The perception of the good as a luxury item.

The elasticity of demand has these following factors: If these conditions are present, the demand for the good is elastic, and a firm may find that a price increase reduces its total revenue.

Total Revenue and Inelastic Demand: Remember that if demand is inelastic, consumers demand is not very responsive to price changes. When demand is inelastic, price and total revenue move in the same direction. An increase in price raises the total revenue and a decrease in price reduces total revenue.

Total Revenue and Inelastic Demand: A decrease in price will lead to an increase in quantity demanded even if demand is inelastic. However the percentage of increase in the quantity demanded will be less than the percentage of increase in price, and the firm s total revenue will decrease.

Elasticity and Pricing Policies: A firm needs to know whether the demand for its product is elastic or inelastic at a given price. The ways that elasticity or demand can affect a firm s total revenue. If a firm knows that the demand for its product is elastic at the current price, it knows that an increase in price would reduce total revenues. On the other hand, if a firm knows that the demand for its product is inelastic, at its current price, it knows that an increase in price will increase total revenue.

Much might be said to the young people regarding their privilege to help the cause of God by learning lessons of economy and self-denial. Many think that they must indulge in this pleasure and that, and in order to do this they accustom themselves to live up to the full extent of their income. God wants us to do better in this respect. {MYP 299.1}

Waste not your pennies and your shillings in purchasing unnecessary things. You may think these little sums do not amount to much, but these many littles will prove a great whole. If we could, we would plead for the means that is spent in needless things, in dress and selfish indulgence. Poverty in every shape is on every hand. And God has made it our duty to relieve suffering humanity in every way possible. {AH 383.2} The Lord would have His people thoughtful and caretaking. He would have them study economy in everything, and waste nothing. {AH 383.3} The amount daily spent in needless things, with the thought, "It is only a nickel," "It is only a dime," seems very little; but multiply these littles by the days of the year, and as the years go by, the array of figures will seem almost incredible. {AH 384.1}

Every week you should lay by in some secure place five or ten dollars not to be used up unless in case of sickness. With economy you may place something at interest. With wise management you can save something after paying your debts. {AH 396.2} I have known a family receiving twenty dollars a week to spend every penny of this amount, while another family of the same size, receiving but twelve dollars a week, laid aside one or two dollars a week, managing to do this by refraining from purchasing things which seemed to be necessary but which could be dispensed with. {AH 396.3}

Discussion Question Try to find ways to save money by listing five things that you feel is unnecessary that you normally buy and explain the reason why it is unnecessary.