Unraveling the mysteries of demand

Price Elasticity of Demand

Estimated read time: 1:20

Summary

The video provides an in-depth exploration of the concept of price elasticity of demand, explaining how it measures the responsiveness of the quantity demanded to price changes. The speaker outlines various types of elasticity and how they are calculated, emphasizing examples and real-world applications. Through detailed examples, viewers learn about the elasticity's effect on revenue and the distinctions between elastic, inelastic, and unit elastic demand, while discussing the factors influencing demand elasticity such as substitutes, budget share, and time. Practical scenarios and theoretical models like perfectly elastic and inelastic demand are also explained to reinforce understanding.

Highlights

Understanding elasticity helps in predicting consumer reactions to price changes. 📊
Two types of elasticities: price elastic where small price changes drastically alter demand, and inelastic where demand hardly changes. 👥
The midpoint formula provides a consistent way to calculate elasticity regardless of direction. ➗
Elastic demand implies revenue changes inversely with price changes, useful for pricing strategies. 📈
Factors like available substitutes can impact a product's elasticity significantly. 🔍

Key Takeaways

Price elasticity measures how much demand changes when prices change. 🎯
Elasticity can be elastic, inelastic, or unit elastic, based on responsiveness. ⚖️
Elastic demand drops more with price increases, while inelastic changes less. 📉
Certain factors like substitutes and budget share affect elasticity. 🔄
Perfect elasticity is theoretical; real-life examples are rare. 🌐

Overview

Price elasticity of demand examines how a shift in price affects the quantity demanded. By comparing percentage changes in price to those in demand, elasticity indicates how sensitive buyers are to price fluctuations. Depending on the response rate, demand can be classified as elastic, inelastic, or unit elastic, guiding businesses on pricing strategies.

To better understand elasticity, fun and detailed examples showcase different situations. For instance, the demand for pizza versus gasoline illustrates the effect of available substitutes. Simultaneously, the importance of budget share is explained through bigger-ticket items like cars versus salt, highlighting elasticity in everyday terms.

Mathematical tools, like the midpoint formula, offer a precise calculation of elasticity, accommodating variances based on directional price shifts. By analyzing elasticity thoroughly, the video not only unpacks a key economic concept but also arms viewers with practical knowledge to infer potential revenue changes based on price strategies.

Chapters

00:00 - 00:30: Introduction to Price Elasticity of Demand This chapter introduces the concept of price elasticity of demand. It begins by acknowledging that the term might sound complex but assures that it is manageable. The core definition provided is that price elasticity of demand measures how responsive the quantity demanded of a good is to a change in its price. This responsiveness is expressed mathematically as a percentage.
00:30 - 01:00: Definition of Price Elasticity Price elasticity measures the responsiveness of quantity demanded to changes in price.
01:00 - 01:30: Elastic vs Inelastic Demand Elastic demand refers to a situation where the percentage change in quantity demanded is greater, in absolute value, than the percentage change in price. In contrast, inelastic demand occurs when the percentage change in quantity demanded is less than the percentage change in price. Essentially, if the demand is elastic, the demand's responsiveness to price change is more significant, whereas inelastic demand indicates lesser responsiveness to price changes.
01:30 - 02:00: Unit Elasticity The transcript explains the concept of unit elasticity in economics, where the percentage change in quantity demanded is equal to the percentage change in price. This contrasts with inelastic goods, where the percentage change in quantity demanded is less than the percentage change in price. The chapter aims to provide a deeper understanding of the condition where elasticity is precisely one, termed as unit elastic.
02:00 - 02:30: Calculating Elasticity with Simple Examples The chapter introduces the basic concept of calculating price elasticity of demand. It emphasizes simple calculations with pre-determined percentage changes in quantity demanded and price, setting the groundwork for more complex calculations later. The chapter aims to familiarize readers with the foundational aspects of elasticity before progressing to intricate scenarios.
02:30 - 03:00: Understanding Elastic, Inelastic and Unit Elastic Demand In this chapter, the concept of demand elasticity is examined, focusing on elastic, inelastic, and unit elastic demand. The relationship between price changes and quantity demanded is explained by discussing a specific scenario where a percentage change in demand (20%) is compared with the percentage change in price (-10%). The lecture highlights the inverse relationship between price and demand quantity, emphasizing that when the price decreases, the quantity demanded tends to increase.
03:00 - 04:00: Cases of Different Elasticities The chapter discusses the calculation of elasticity of demand using the formula: the percentage change in quantity demanded divided by the percentage change in price. In the example given, the elasticity is calculated as -2, meaning that a 20% change in quantity demanded corresponds to a 10% change in price. The chapter notes the convention in economics to express demand elasticity as a negative number due to the inverse relationship between price and quantity demanded.
04:00 - 05:00: Midpoint Formula for Elasticity The chapter "Midpoint Formula for Elasticity" explains the calculation of price elasticity using the midpoint formula. It focuses on handling negative changes in quantity demanded when prices decrease, highlighting that elasticity calculations often drop negative signs by using absolute values. This approach simplifies the calculation process, as one only needs to divide the absolute changes in quantity and price to find the elasticity.
05:00 - 06:00: Examples of Perfectly Elastic and Inelastic Demand The chapter titled 'Examples of Perfectly Elastic and Inelastic Demand' explores the concepts of price elasticity and inelasticity. It opens with clarifying definitions, prompting the reader to think critically about the given example to determine whether it represents elastic or inelastic demand. It notes that for a demand to be elastic, the percentage change in quantity demanded (in absolute value) must exceed the percentage change in price (in absolute value), while the reverse is true for inelastic demand.
06:00 - 07:00: Factors Affecting Price Elasticity of Demand The chapter focuses on the factors affecting price elasticity of demand, using a specific example to explain the concept. It begins by examining a scenario where the percentage change in quantity demanded is 20% compared to a 10% change in price, demonstrating an elastic demand. It highlights the responsiveness of quantity demanded when the price change is smaller than the change in quantity demanded. The example illustrates that when the price decreases by 10%, the quantity demanded increases by 20%, showcasing a product with price elastic demand.
07:00 - 08:00: Elasticity and Total Revenue The chapter "Elasticity and Total Revenue" discusses the concept of elasticity in economics, particularly focusing on price elasticity of demand. It introduces the idea of a good being elastic when its quantity demanded is responsive to changes in price. Through example two, it demonstrates how to calculate elasticity: a 5% decrease in quantity demanded against a 10% increase in price yields an elasticity of 0.5, disregarding the negative sign.
08:00 - 09:00: Implications of Different Elasticities on Price Changes The chapter titled 'Implications of Different Elasticities on Price Changes' discusses the concept of elasticity in economics, specifically looking at how it affects price changes. The transcript provides an example where a fraction, when reduced, indicates an elasticity of 0.5 or a half, illustrating a specific case of inelastic demand. It clarifies that if the percentage change in quantity demanded is greater than the percentage change in price, the demand is considered elastic. Conversely, if the percentage change in price exceeds the quantity demanded's percentage change, the demand is inelastic. This chapter likely explores the broader effects of these elasticities on pricing strategies and market dynamics.
09:00 - 10:00: Elasticity Variation on Linear Demand Curve The chapter discusses the concept of price elasticity on a linear demand curve using a specific example. It notes a scenario where the price of a good rises by 10%, but the quantity demanded only falls by 5%, indicating inelastic demand since the percentage change in quantity is less than the percentage change in price. The summary emphasizes understanding the number changes in elasticity, differentiating between elastic and inelastic demand, where elasticity implies a larger percentage change in quantity demanded compared to price.

Price Elasticity of Demand Transcription

00:00 - 00:30 okay now we're going to turn to our next topic which is elasticity and we're going to focus now on what's known as price elasticity of demand now it sounds like a complicated term it's a little complicated but we're going to be able to handle it just fine here's the definition of price elasticity of demand price elasticity of demand measures the responsiveness of quantity demanded to a price change and it's represented by the following mathematical formula the percentage
00:30 - 01:00 change in quant demanded divided by the percentage change in the price and that's how you would calculate elasticity now basically what is elasticity it basically gets at the idea of this is when price goes up we know people buy less right price goes up quite a minute goes down but for some goods when price goes up people buy a little bit less and for some goods when price goes up people buy a lot less so we're trying to distinguish between those two different kinds of goods so the one of the cases is called price
01:00 - 01:30 elastic so if a demand is considered price elastic all right it means this it means the percentage change in quantity demanded in absolute value is greater than the percentage change in price in absolute value that is the magnitude of the change in quant demanded is greater than the magnitude of the percentage change in price that is if it's elastic if it's inelastic it's the opposite the absolute value the percentage change
01:30 - 02:00 in quant demanded is less than the absolute value of the percentage change in price then it would be inelastic that is to say if the magnitude of the percentage change in quantum demanded is less than the magnitude of the percentage change in price then you would say the good is inelastic now there's a case in the middle called unit elastic and that just means that the percentage change in quant demanded in absolute value is equal to the percentage change in price in absolute value so what i want to do now is i want
02:00 - 02:30 to turn to how you calculate the percent how you calculate a price elasticity of demand and that we are going to turn to now okay before we do some more complicated calculations of the price elasticity of demand i just want to do a few simple calculations where the percentage changes in quantity demanded and the percentage change in price already already done for you all right so if we take a look at example one here we see that the percentage change in quiet
02:30 - 03:00 demanded is 20 and the percentage change in price is 10 as a matter of fact let's put the percentages in there uh to remind you that they're there um and so if you take a look at this particular problem uh the percentage change is 20 for quantum demand and percentage change in price is negative 10. notice this is what i talked about earlier if the price is going down the quantum mana is going up so when this is positive this is always negative so if we were to do that
03:00 - 03:30 calculation um we're using this formula right the percentage change in quantity demanded divided by the percentage asian price you get the elasticity of demand is 20 uh divided by negative 10 which is equal to 20 divided by negative 10 a positive divided by a negative is a negative so it's negative 2 right 20 divided by 10 is is 2. negative 2. now here's the thing though remember what i told you a few a few moments ago that uh because it's so obvious to economists that the
03:30 - 04:00 when the price change is negative the quantity managed change will be positive and vice versa because it's it's always going to yield a negative calculation we basically just drop the negative sign so instead of saying negative 2 we just say 2 and the mathematical term for this is absolute value so technically when you're doing these problems you're not worrying about the negative signs you're just going to do 20 divided by 10 in 20 divided by 10 instead of instead of having the negative sign in there so you just get
04:00 - 04:30 the num the number two now what i'd like you to think about though in terms of those definitions that i gave you a few moments ago in terms of inelastic versus elastic is the problem that i just did here in example one an example of a price inelastic demand or a price elastic demand well let's let's take a look if you remember if it's uh elastic the percentage change in quantity demanded in absolute value is greater than the percentage change in price and absolute value and for inelastic it's the opposite
04:30 - 05:00 so what's going on here well the percentage change in quantum demand was 20 the percentage change in price and absolute value just the magnitude of the change was 10 so the amount the percentage change in quiet demanded is greater than the percentage change in price so this would be an example of a good who's uh demand is price elastic um and notice why it's responsive right the price only changed by 10 yet people bought um price went down by 10 people bought 20 percent more it's
05:00 - 05:30 responsive so therefore we call it elastic let's take a look at example two in example two we have a percentage change in quantity demanded of negative five percent of the percentage in there again um and the price change in this example was a positive ten percent so the question becomes what's the elasticity well the elasticity will be remember just drop that negative sign we're not going to worry about it it's going to be 5 divided by
05:30 - 06:00 10. so 5 divided by 10 when you reduce that fraction is just one half so you're going to list the elasticity of a half or if you like uh decibels it's 0.5 so that's that elasticity now again let me ask you the question is that inelastic or elastic well remember percentage change in quine demand and if it's greater than the percentage change in price again dropping the negative signs then it would be elastic and if the percentage change in price is greater than the percentage change in quantity demanded then it would be inelastic well
06:00 - 06:30 here you can pretty clearly see the change in price was ten percent price rose by ten percent but quant demand only fell by five percent not very responsive so we would call that uh that would call that demand price inelastic all right and that's a simple calculation of elasticity okay i just want you to notice something about uh when something is in the last elastic or when something is inelastic right we said when it's elastic this number the percentage change in quant demanded is going to be greater than the percentage change in the price at least
06:30 - 07:00 the magnitudes right the absolute values and if it's inelastic the percentage change in quantity demand is going to be less than the percentage change in price so what does that mean about the value of elasticity well you should be able to see that if elasticity of demand is defined as the percentage change in quantum demand divided by the percentage change in price and if we're saying if it's elastic this number has to be greater than this number you should be able to see that something will be
07:00 - 07:30 elastic what the calculation for elasticity will be greater than one any time it's elastic right because if this number is bigger than this number you're always going to get a number bigger than one you can try this out in the scrap paper so that's an important part of the definition of of elastic it's when the percentage change in quantity demand is greater than percentage change in price as we've discussed and its calculation will always come out to a number greater than one for the case of when something is inelastic we said right the percentage
07:30 - 08:00 change in quantity demanded is less than the percentage change in the price that means that the numerator the percentage change in quantity demanded is always going to be less than the percentage change in the price which you should be able to see right away that you're always going to have a number that's a fraction right if this number is smaller than this number the number is always going to be less than 1. so if something is elastic it has elasticity which is greater than one if something is inelastic it's um its value is between
08:00 - 08:30 zero and one and then there is that one case of if you remember i said unit elastic and that's when the percentage change in quiet demanded is exactly equal to the percentage change in the price well this number is equal to this number it's going to elasticity of demand is going to equal one so those are your three cases right if it's elastic the value of the elasticity will be greater than one if it's relatively inelastic then the value of elasticity will be less than one greater than zero and less than one and
08:30 - 09:00 then if it's unit elastic it will be exactly equal to one what i want to turn to now is uh what happens when you actually have to calculate the percentages i calculated the percentages for you here that made the problem easier i'd like to do a problem where we have to calculate the percentages as well and we'll do that now okay now we're going to try to show you the or i'm going to try to show you the price elasticity of demand when we have to calculate the percentage changes in the quantity demanded and the percentage change in the price so here's
09:00 - 09:30 the problem once you imagine that you have a old price of three dollars and you have an old quantity demanded of 15 that is to say at this price that used to exist at 3 people used to buy 15 units of this product now we're going to imagine the price rises from 3 to 5. 5 is the new price and as a result of that the quantity amanda which used to be 15 now falls to 5. so the question is is it responsive is it not responsive is it inelastic is it elastic and for this we have to calculate the elasticity so here's that formula elasticity of demand
09:30 - 10:00 is equal to percentage change in quantum demand divided by the percentage change in the price okay so how do you figure out a percentage change in a product or in anything you take the new quantity demanded and you have to subtract the old quantity demanded that's the magnitude of the change but to put it in percentage terms you have to divide by what you're starting with which in this case is your base right so in this case that's the old quantity demanded so to figure out the percentage change in quantity matter you take the new coin demanded you subtract it from the old quantum and it and you divide it from
10:00 - 10:30 where you started started from that's the old coin demanded you then do the same thing for price new price minus old price to figure out the change in the price and you divide from where you started from which is the old price so if you take a look in this problem uh the new quine demanded we said was five the old quantum demanded was 15. so we plug in 5 minus 15 and then we plug in the old quantity demanded which was 15. so the numerator of the fraction is 5 minus 15 divided by 15. then in order to figure out the
10:30 - 11:00 percentage change in the price you do the same thing uh new price minus the old price it's 5 minus 3 divided by the old price divided by 3. all right so 5 minus 15 is negative 10. you might say well why'd you drop the negative sign remember when we're doing elasticity we're not going to worry about the negative sign we're just going to worry about that absolute value the magnitude of the change so 5 minus 15 is 10 and now we divide it by 15 which was the old coin a minute so your numerator is now 10 divided by 15.
11:00 - 11:30 you do the same thing for the price 5 minus 3 is 2 and then you divide that by 3. so now your denominator is 2 divided by 3. so now you have to do 10 divided by 15 divide divided by 2 divided by 3. well 10 divided by 15 is just 2 3. now again if you have to take a look take a scrap paper and see if you can reduce that fraction the common uh the common factor of both 10 and 15 is 5. so you can reduce you divide ten by five that's two and you divide fifteen by five and
11:30 - 12:00 that's three so ten fifteenths is the same thing as two thirds so we've got two thirds which is the ten divided by fifteen divided by two thirds which is equal to one right and any number divided by itself is one and if you remember from earlier i said that that's that kind of random case where you have something called unit elasticity it's neither elastic nor inelastic it's that that point right in between all right so you might say okay that's that's kind of complicated but it's it's not it's not too bad it's doable but there's a problem with what we're
12:00 - 12:30 doing and i want to try to show you the problem with doing the percentages in that simple formula when we take a look at what happens when we go the other direction all right so if we go the other direction it's the same numbers now same numbers same product except instead of going starting with a price of three we're going to start with a price of five instead of starting with a quantity minus 15 we're going to start with one of five and we're gonna go back in the other direction so the quan the new coin a minute is going to be 15 and the new
12:30 - 13:00 price is going to be three so this is for a case where price is dropping from five to three all right now you would think that you're going to get an answer of unit elastic again right because all we're doing is the same problem we're just going in having prices drop as opposed to pricing prices rise let's take a look at that's the case when we plug into our formula right we do the new quantum and minus the old coin a minute that's 15 minus 5. that's 10 again and this time though we don't divide by 15 we divide by 5 because that's our starting point the 5 is our starting
13:00 - 13:30 point so our numerator becomes 10 divided by 5. we do the same thing for the price we just reverse the numbers instead of doing five minus three we do three minus five don't worry about the negative sign so that's two but again now we have a different base we're starting from a different point so instead of dividing by um three as we did before we're going to divide by 5. so you get the denominator is now 2 divided by 5. all right so doing the calculations 10 divided by 5 is the number 2 right
13:30 - 14:00 and then for the and that's divided all by the two-fifths now some of you might say i need to calculate this point hopefully you can kind of do this do this using simple fractions so two divided by two-fifths uh what do you do you take that reciprocal so you do two over one that's the number 2 right 2 divided by 1 is number 2 and you multiply it by the reciprocal of 2 fifths you flip the fraction so it's 2 divided by 1 multiplied by 5 over 2
14:00 - 14:30 and you get the number 10 halves right 5 times 2 is 10 1 times 2 is 2 and and that's 10 over 2. you could have done it by the way a very simple way you could have just reduced the the fraction right instead of doing um you could just cross out that two and cross out that two make these both ones and then do five divided by one but it doesn't matter either way you're going to get the same answer 10 divided by two is five but you should see the problem now right the problem is that the product is elastic actually fairly significantly
14:30 - 15:00 elastic right with an elasticity of five much greater than one so it's weird right we went in one direction we got the number one we went in the other direction we got the number five and that shouldn't be and so if we think about what's causing the problem well what's causing the problem is when we do these division problems because we're starting it's not the the new the 15 minus 5 is not the problem any more than the 3 minus 5 is the problem because dropping the negative signs you're going to get the same number but what's the problem is
15:00 - 15:30 because the old quantity demanded was 15 and now the and now it's been flipped to five and the old price was three now it's been flipped to five you're getting it you're dividing by a different number instead of dividing by 3 as we were over here you're dividing by 5. instead of dividing by 15 over over here we're now dividing by 5. so we've got to come up with a formula that gives us a consistent answer on elasticity and so that's called the midpoint formula and that's what we're going to turn to next
15:30 - 16:00 okay let's look at the same problem we just did but we're going to use something called the midpoint formula so if you notice the numbers on quantity demanded and price are the same right new coin demanded uh old coin demanded is it's news five old's 15 price is five old price is three now if you remember depending on which direction we would go would throw off the problem so the midpoint formula says we're gonna solve that now when i first saw the midpoint formula as a student scared the heck out of me even when i first started teaching and i was like this seems very very complicated it's nowhere near as bad as
16:00 - 16:30 the formula indicates so i've put the formula in bold here and as you can see it's a lot right um and so if you what basically has happened though with the midpoint formula is it takes a look at the part of the problem that was throwing us off and if you remember it was this part of the math that was throwing us off because when we went in one direction we had we divided by one number and we went in another direction we divided by another number and the same thing for this section so here's here's the thing we have a change right quantum demand
16:30 - 17:00 has changed from 15 to 5 or from 5 to 15. and so the question is well what should i divide by because if i divide by 15 if that's my base i'm going to get a different number than if i divide by 5. so the midpoint formula says is let's just have a compromise let's just find a point in the middle and use that number for both situations so what we would do using the midpoint formula instead of using 15 as we did in one problem before and five as we did in the other we're just going to say let's split the difference so you take 15
17:00 - 17:30 i'm sorry 5 and you add it to 15 5 15 is 20 and you divide by two you take the number 10. but i can because you can kind of ballpark that just by looking at it right in between 5 and 15 is the number 10 but that's all the midpoint formula is doing that's all we're doing is we're taking the compromise number same thing with price we have price of new prices five old prices three under the previous formula we would have had to pick between five and three the midpoint formula says don't pick
17:30 - 18:00 just make the compromise choice so what's the compromise choice between five and three it's four so when we go in one direction we'll use four when we go in the other direction we'll use four we always use that compromise number and that's all this formula is it looks more complicated than it is so let's take a look at how it would play out in this problem all right so 5 minus 5 minus 15 or 15 minus 5 doesn't matter remember we dropped the negative signs and we know that number is 10. it was in both of the problems that we just did if you look back at your notes look at your notebook you'll see that it's 10. now it's the
18:00 - 18:30 base right before some of the problems we divided by 5 some of the problems we divided by 15 depending on what direction we're going well what are we going to do now we're just going to add them together and divide by 2. that'll give us the compromise number so we're going to take 20 and divide it by 2 and that's going to give us the number 10. so that's all we're doing and then we do the same thing with price 5 minus 3 or 3 minus 5 doesn't matter what direction we go because we're going to drop the negative signs we're going to get the number 2 and then for the
18:30 - 19:00 for the denominator here we're going to take that compromise number we're not going to use 3 we're not going to use 5 we're going to use a number in between which is 4 right and 3 plus 5 is 8 divided by 2 is 4. um so 8 divided by 2 you can see is 4. so the number we have now is it's 10 right that was the difference between 5 and 15 divided by the compromise number which was 10 over 2 right the difference between 5 and 3 divided by the compromised number which is 4.
19:00 - 19:30 so 10 divided by 10 is reduced to 1 and 2 divided by 4 is reduced to 1 half so now the number that we have in the midpoint formula for figuring out elasticity for this problem is one divided by one half how do we do that problem well the easiest way to do is just flip the fraction so you have the number one is this equivalent to one over one and then you multiply it by instead of doing the division you multiply it by the reciprocal you flip the bottom
19:30 - 20:00 fraction so one divided by one multiplied by two over one and that equals two over one which is the number 2 which means using the midpoint formula it's elastic so in economics generally speaking the midpoint formula is more accurate on the test i might ask you to do one question with the midpoint formula no you won't use the need a calculator i will do some things hopefully simple that you can just kind of calculate uh you know on the side in your scratch paper the other formula is you can use it but it's not as accurate because it gives
20:00 - 20:30 you one answer going in one direction and one answer going the other so this is how you use the midpoint formula to calculate the price elasticity of demand what i just want to show you here is two extreme cases of elasticity right we've just talked about the cases of when demand is price inelastic and when demand is price elastic so the question is what does the graph look like if it is if it is as extreme a case as possible
20:30 - 21:00 so on the left here we have i've listed perfectly priced and we're going to try to determine whether this demand curve is perfectly priced inelastic or perfectly price elastic so if you remember elastic is when demand is relatively responsive inelastics when it's relatively not responsive so let's take a look at this graph is this some situation where people are really changing their behavior when the price changes are really not changing their behavior let's take a look when the price is going up right price is going up the amount demanded is staying
21:00 - 21:30 exactly the same doesn't matter how much price goes up the amount people buy stays exactly the same well does that sound responsive to you or not responsive you should be saying not responsive right people aren't changing their behavior at all when the price rises um so that is the case of what's called perfectly it's a perfectly priced inelastic demand curve so let's fill that in perfectly price inelastic demand curve um and um what would be the value of its elasticity well if you remember elasticity um something is inelastic
21:30 - 22:00 when the value of elasticity is between zero and one and when something's uh elastic it's greater than one so what is situation is this this is a situation where it is as inelastic as possible that means it's as far away from us being responsive as it possibly can be so that means that it's going to be the value of the elasticity is going to be uh is going to be zero um right because if it's inelastic it's between zero and one and when it's zero that's as inelastic as it possibly can be now some
22:00 - 22:30 of you should be screaming right now and saying wait a second what about this demand curve it's kind of bothering me because it doesn't have a negative slope um it doesn't it it's not showing inverse relationship as a matter of fact this demand curve violates what's known as the law of demand right well demand says when price goes up people buy more assuming everything else stays the same in this graph when price goes down people buy the same when price goes up people buy the same so this demand curve is something that we use in economics as a theoretical uh concept but it does not exist in the real world right there's
22:30 - 23:00 always a law of demand and the reason why there's always a lot of demand is there's always income effects when price goes up even if you think you absolutely need to have the good when price goes up your purchasing power is going to go down and you're not going to be able to buy the buy the good so this is a case of a perfectly priced inelastic demand curve well that leaves you with really no other option on the next one which you know is going to be perfectly priced elastic so what does this mean a perfectly priced elastic demand curve it means that if the price of this
23:00 - 23:30 product were to go up even the slightest amount people would stop buying the product entirely okay they wouldn't just buy less they wouldn't buy it at all that's how responsive it is um so um if you look it's kind of hard to see with the demand curve we're going to make late use of this later well basically this if the price stays at this level whatever this price is right here then people can buy will buy an infinite amount at this particular price but if the price were to rise even sliced a bit they'd say i'm not i'm not
23:30 - 24:00 i'm going to buy it all so if you were a firm facing this demand curve you would say okay if i if i charge this price i can sell as many my as much of my product as i want but if i raise my price then i will lose all custom all my customers okay and that's perfectly price elastic um sometimes people say uh what are examples of price inelastic and price elastic i already told you the price inelastic doesn't exist in the real world because of income effects but
24:00 - 24:30 something that might be price perfectly pricing in the last six times people say oh well the the demand for insulin for diabetics is perfectly price inelastic because if the price goes up they have to buy it or they're going to die but the truth of the matter is the price goes up into out of their out of their budget they're going to have to buy less whether they're going to die or not in the case of perfectly priced elastic will be an example of this maybe something like wheat
24:30 - 25:00 if you were a farmer and you were selling wheat um if you're if you raised your price of your wheat higher than other farmers price of their wheat people just go to another another farmer they wouldn't they wouldn't they wouldn't buy from you at all but as i said these are pretty extreme examples it's hard to find examples of perfect price elasticity and perfect price inelasticity doesn't equal in the real world oh one thing i forgot to say what would be the value of the elasticity if it's perfectly price elastic well if you remember if it's price elastic it means
25:00 - 25:30 that the elasticity is greater than one so if it's perfectly priced elastic it's as far away from one as you possibly can imagine it's two is more elastic three is more elastic four is more elastic five is more elastic so if it's perfectly priced elastic then it is the value of its elasticity is infinite and those are the two extreme cases now what we're going to talk about eventually is we're going to talk about what are the factors which make something relatively elastic or relatively inelastic but
25:30 - 26:00 these are the extreme cases so if it's just regular inelastic we call it relatively inelastic if it's this we say it's perfectly priced inelastic if it's just regular elastic we call it relatively elastic if it's this situation this extreme situation we say perfectly price elastic okay and so again eventually we'll start to talk about the factors which affect elasticity
26:00 - 26:30 okay now that you see how price elasticity of demand is calculated what i want to do next is talk about the factors which affect the price elasticity of demand how come some goods are considered price elastic and some goods are considered price inelastic okay so the first factor which affects elasticity is maybe illustrated by the following example what do you think is more elastic what do you think people respond more to price on if there's a change in
26:30 - 27:00 the price of pizza or if there's a change in the price of crack cocaine or if you want something less serious price of gasoline which do you think is more elastic the price the demand for pizza or the demand for gasoline now hopefully you are saying oh i think people are going to be able to respond much more when there's a change in the price of pizza than when there's a change in the price of gas and why is that well because if the price of pizza goes up right you're gonna be able to change your behavior significantly because you have a whole bunch of other options out there go get chinese food go get other kinds of italian food go get
27:00 - 27:30 hamburgers go get there's a lot of different options that you have when the price of gas goes up yes you're going to buy less we know that right because um people buy less when the price goes up there's the law of demand but it's harder to substitute for that product than it is for other products right um so because it's hard you know you can change your behavior but it's harder to so things like gasoline cigarettes drugs these tend to be inelastic goods because there are less substitutes goods like pizza would have be more elastic
27:30 - 28:00 because there are more substitutes so that's the first factor which affects elasticity the number of substitutes the more substitutes the more elastic demand is the less substitutes the more inelastic price inelastic demand is okay that's the first factor second factor um again let me try to do with an example then we'll see what the second factor is what do you think is more price inelastic the demand for automobiles or the demand for salt now some of you might be trying to reason this through with substitutes i don't
28:00 - 28:30 want you to do that forget the substitute argument without making a substitute argument can you make an argument about what's more inelastic the demand for salt or the demand for automobiles well let me give you a hint it has to do with a person's income and it has to do with the price of of each product let me let's think of it this way what if the price of salt were to were to double an astronomical increase in the price of salt it would double it would go from i don't know 1.50 for one of those small jars to three dollars
28:30 - 29:00 would that significantly impact people's decision to buy salt probably not because it's such a small percentage of your budget you probably don't even think about it so when the price of salt doubles you're not going to suddenly change your behavior significantly the quantity demanded percentage quite man is not going to fall off by more than 100 percent because it doesn't impact your budget very much but think about the car example if the price of cars were to double that would significantly impact people's budgets they couldn't afford them and so their quantum percentage
29:00 - 29:30 change in quantum demand was dropped significantly or more significantly than assault and that so that's really the second factor which affects price elasticity of demand the share of a budget of the budget the good is right so if the good is a larger share or a larger proportion of your budget it's more likely to be elastic right cars are a much larger percentage of your budget than salt is so it's going to be more elastic the larger the share the larger the proportion it is of the household budget the smaller the share the smaller the proportion it's going to be more inelastic and hopefully
29:30 - 30:00 you can see that effect the third factor which affects the price elasticity of price elasticity of demand that we're going to talk about maybe is illustrated by this example actually students hate this example i love this example so i'm going to do it because i'm a teacher and fine if it doesn't work if you don't like it then i'll do a different example um what happens to the demand for plutonium in the year 1985 does it become more elastic or more
30:00 - 30:30 inelastic as time goes on now a lot of you like what are you talking about demand for plutonium 1985. please tell me you understand the reference well let me try to give you a better hint if you want to engage in time travel in the year 1985 you absolutely need plutonium at least at the start please tell me you know we're talking about right now if you don't what a tragedy this is you need the plutonium to operate the flux
30:30 - 31:00 capacitor to generate the 1.21 gigawatts of electricity necessary to make a delorean engage in time travel please tell me you know it now yes back to the future right if you remember back to the future the demand for plutonium at the beginning that movie is really inelastic because you need plutonium in order to engage in time travel but by the end of the movie you don't need plutonium because the flux capacitor now runs on garbage there's a fusion uh mr fusion allows the allows time travel to occur allows you to
31:00 - 31:30 generate the energy i know some of you like some of you saying i don't even know back to the future that's tragedy by the way you should know back to the future i don't understand what you're talking about fine i'll do a nice boring example which will make it easier for you to see instead of talking about something interesting like back to the future what was true about the demand for railroads in the year 1985 the demand for railroad 1985 what was true by the demand for railroads in the at the turn of the century uh in the united states at the turn of
31:30 - 32:00 the 20th century in the year 1900 the demand for railroads was inelastic why because there weren't very many substitutes but what happened over time over time substitutes for railroads were developed like cars and planes and so forth so the demand for railroads became more elastic happy now back to future examples much better um so when it comes to uh the time when it comes to this third factor it's time right over time
32:00 - 32:30 goods tend to become more elastic for really two reasons one more substitutes are developed by the market and secondly you're able to adjust easier think about if the price of gas doubled tomorrow you're probably gonna have a tough time changing your consumption of gas in the short term but in the long term you'll start to carpool you might take mass transportation you might change your schedule so that your school classes were all on a couple of days rather than spread out through the week you might change your work schedule etc these are things you can't change in the short run but over the long period of
32:30 - 33:00 time you can change so that's the third factor which we're going to talk about which affects elasticity that is time over time demand tends to become more elastic in a shorter period of time demand tends to be inelastic so those are three basic factors which affect the price elasticity of demand what we want to do next is we want to talk about some public policy examples which use elasticity but before we can do that we have to talk about something called
33:00 - 33:30 elasticity and total revenue and that's actually where we're going to turn to next okay we're going to talk about now is the relationship of price elasticity of demand and something called total revenue uh just let me understand you understand what i mean by total revenue total revenue is the amount of money coming into the business here's a simple example if my daughter's running a lemonade stand okay how would i figure out how much money
33:30 - 34:00 she has coming into the lemonade stand right i by the way i'm not talking about profit now i'm talking about revenue all right some parents uh make this confusion which we'll talk about in a second but if i wonder how much revenue my daughter is making with her lemonade stand i would need to know the price of the lemonade and i need to know the amount that she sold and if i take the price times the amount that she sold that'll give me total revenue the amount of money coming in i know some of you like well what about the cost of running lemonade stand that'll give me profit but i'm actually
34:00 - 34:30 very disturbed about a lot of parents i think a lot of parents are running telling teaching their kids terrible things i think they're confu having them confuse the difference between revenue and profit because uh because a lot of the parents that i know are are just providing the the services providing the cost or paying for the cost themselves i remember when i my daughter first ran her first lemonade stand she came in she said oh i i made ten dollars i said yeah revenue she said well what do you mean i said revenue that's the money you have coming
34:30 - 35:00 in now we're going to talk about your costs because guess what i provided the lemonade powder that's money i actually made the lemonade that's more money and lastly i had to sit there and watch you while you picked an activity to entertain yourself which involved you to going down in the street and handing things to strangers in cars and vans i had to watch you i'm going to charge you abduction prevention costs because it really cost me my time my time is valuable to me so it actually turned out she ran her first lemonade stand at a loss but she worked it off so don't worry
35:00 - 35:30 about it i know something like you're a terrible parent no i don't think i'm a terrible parent i'm teaching my kids important lessons the difference between prof between revenue and profits right some parents aren't teaching their their kids that at all and if you think i'm being mean to be honest with you on the day that she ran the lemonade stand at a loss where she made revenue but not a profit i told her not to run the lemonade stand i told her this is a rainy day it's not hot out it's a terrible business plan on your part but you know five-year-olds you know do what they want i guess oh she learned her lesson she had to work off her loss um so um this is the this is what i do with
35:30 - 36:00 my children i don't know what other parents are doing in any event we now have to talk about the relationship between the price elasticity of demand and revenue so let me ask this let's just stick with my daughter's lemonade stand should my daughter raise the prices of her lemonade should she lower the price of her lemonade well what she should do depends on elasticity with a price elasticity of demand if the pr if let me ask this question let's just let's just ask this general question if the price of lemon if the
36:00 - 36:30 price of the product lemonade or otherwise were to go up we know the price would go off we know people were going to buy less the question becomes how much less are they going to buy if the price goes up are they going to buy a lot less or are they going to only buy a little bit less so what i want to do is i want to show you on a piece of paper what what the equations are and what happens to total revenue when you're dealing with an inelastic product or when you're dealing with an elastic product and that'll tell us what my daughter should
36:30 - 37:00 do in terms of prices okay so let's try to address that question i was talking about about whether you should raise or lower prices if you're concerned about your revenue and as we said that depends on whether the demand is inelastic or elastic so let's take a look let's assume we're talking about a good who has a demand which is inelastic inelastic and total revenue we said right not the profits total revenue is equal to price times quantity
37:00 - 37:30 so if your demand if you believe your demand to be inelastic should you raise prices or lower prices so let's take a look at how that might work let's say you raise prices by 10 and you believe the demand for your product to be inelastic okay 10 so when you raise prices we know that people are going to buy less from you that's automatic that's law of demand the question becomes how much less how much business are you going to lose when you raise prices so let's say you if you think your demand for your products inelastic we know that means that the amount demanded is going to drop by a
37:30 - 38:00 lower percentage than the change in the price so pick a number we'll pick a number arbitrarily here let's say something like six percent so price is going up by ten percent uh the amount demanded is going to go down and that you're able to sell to people is going to go down by we said six percent well if you can look at the numbers here the price effect the fact that you're multiplying by a higher number right the higher price which has gone up by 10 is going to dominate your loss sales of six percent right you're gonna lose six
38:00 - 38:30 percent of your of the amount that you sell so that means that the revenue is definitely going to go up because the price effect dominates the loss uh quantity demanded so if it's if you have an inelastic demand you should and you have control over your price you should raise the price of your product because that'll tend to increase revenue again if we're not worried about profits at this point in time we're just discussing discussing revenue all right so um what would be the situation if it was inelastic and you lowered prices
38:30 - 39:00 well let's put price times quantity over here let's say you lower price again we'll just use arbitrarily the number 10 percent so let's say you lower prices by 10 well again if you lower prices you're going to pick up some buyers right people are going to start to buy more law of demand the question is how much more well if it's inelastic remember that means that the amount demanded is going to rise by less than the price dropped right if you remember your definitions of elasticity right so the amount demand is going to go up by
39:00 - 39:30 make up a number we'll say uh four percent in this case so price has fallen by ten percent uh quantum demands only go by four percent that means your revenue is going to drop okay so remember again uh if something is inelastic it means the percentage change in the quantity demanded is going to in absolute value is going to be less than the percentage change in the price which means it would be a good idea if you wanted to maximize your revenue or increase your revenue to raise prices that'll raise revenue on the other hand uh if you lower prices in this situation
39:30 - 40:00 uh because it's inelastic the responsiveness is not it's not going to be very responsive buyers are not going to respond to the price cut they're only going to buy a little bit more or in more precise terms the amount demand is going to increase by less than the price drop which means your revenue is going to drop so if you have an inelastic demand and you want to raise your revenue you'd raise prices you would not lower them because that would lower your revenue let's turn to the case of when something is elastic
40:00 - 40:30 okay let's take a look at the opposite case when you believe the the demand for your product is price elastic okay not perfectly elastic just regular price elastic okay so if that's the case again let's take a look at total revenue it's equal to price times quantity now again remember what the definition of elastic is is that means that the percentage change in the quantity demanded is going to be greater than the percentage change in the price so in this case if you raise prices again we'll arbitrarily pick 10
40:30 - 41:00 if you raise prices by 10 and you believe the demand for your product is elastic then people we know people are going to buy less the question is how much less well if it's elastic they're going to buy significantly less they're going to buy the quantity demand is going to drop by more than the price increase so this is going to go down by will make up some number 15 percent which means if the price is rising by ten percent but the quantum demand is dropping by fifteen percent that means that your revenue is going to you should see it's going to fall i've tried to
41:00 - 41:30 help you out by having a larger arrow here and a smaller small smaller arrow there so that you can kind of see it the revenue is going to drop all right on the other hand again putting the same equation for total revenue if it's elastic and you lower prices by again arbitrarily 10 what's going to happen the amount demanded well it's going to go up and it's going to go up significantly by something more than 10 percent because it's responsive because it's elastic and that means that it's going to go up again we'll make up some number let's
41:30 - 42:00 say it goes up by 17 or something arbitrary like that so price drops by 10 and it's elastic then the amount a bit people buy from you is going to increase by more than the price drop which is going to have the effect of increasing your revenue right because you're making up for the lost price the lower price with with increased with significantly increased sales so if you had a demand which was price elastic then then you should um you should lower your prices if you were
42:00 - 42:30 interested in gaining revenue and you wouldn't want to raise them because then revenue would would decrease okay now you've seen that that there's a relationship between the price elasticity of demand and total revenue the question is what should my daughter do should she raise prices or lower prices well this as you know depends on whether the demand for her lemonade is inelastic or elastic well a lot of you are probably saying oh it's elastic because a lot of substitutes for lemonade remember that first factor then there certainly are a lot of substitutes for lemonade but are there a
42:30 - 43:00 lot of substitutes for kids lemonade i remember once i uh my girlfriend sent me down the street to buy lemonade from one of the kids lemonade stands down the street and she sent me down there and um i came back a few minutes later and she said where's the lemonade and i said i didn't buy the lemonade she said you have to buy the lemonade i said no i didn't buy lemonade it was too expensive given what they were giving me wasn't a good deal so i walked she said you can't walk away from the little kids you have to buy the lemonade i said why should i have to buy the lemonade it wasn't a good deal she said that's not the point you're just there to support the little kids to give them
43:00 - 43:30 money so i said i guess i guess the lemonade doesn't even matter to this process i guess it's totally superfluous they should just sit there with a sign that says give me money i'm a cute neighborhood kid it's ridiculous but anyway any event i had to go back down and buy lemonade from the kid if kids overpriced lemonade and so while lemonade itself may be elastic i think little kids lemonade on a street is probably inelastic because you really can't buy another product from somebody else you're really just supposed to buy the little kids lemonade something i was painfully unaware of um or painfully
43:30 - 44:00 became aware of so what should my daughter do well if the demand for her lemonade for her lemonade is inelastic she should jack up that price and that's what i tell her to do to try to take advantage of the neighbors because apparently they don't think they're a substitute for little kids lemonade so again if you think it's elastic then she should lower prices but if you think it's inelastic you should raise the prices at least if you're interested in in revenue okay so that concludes our discussion on the relationship between the price elasticity of demand and revenue
44:00 - 44:30 okay the issue we're going to talk about here is how elasticity can change over a demand curve i've been talking about demand being inelastic or elastic but it may it may be the case that the elasticity changes even along a single demand curve and so we're talking about elasticity and what's called the linear demand curve kind of an oxymoron a straight line demand curve um so we're going to draw a graph here
44:30 - 45:00 price is going to be the vertical axis quantity is going to be on the horizontal axis and here is our demand curve okay straight line which a straight line for those of you not uh familiar mathematically means the slope is constant so let's take a point on this uh on this demand curve which is right here and we're going to assume that the price in this case is 90 and
45:00 - 45:30 i'm sorry and the amount demanded is 100 and we're assuming the price drops to 80 the amount demanded increases to 200. so that's a slope of 1 10 right slope is rise over run right the amount uh price is changing uh on our vertical axis that's 10 and my quantity is changing is is by a hundred okay so that ratio that when this drops by 10 this increases by a hundred has to remain the
45:30 - 46:00 same so if i were to take another point over here let's say this is for 20 this is 800 units right if you notice when this drops by 60 this increased by 600 still maintaining that 1 10 ratio and when price drops to 10 the quantity is at 900 this is a straight line demand curve
46:00 - 46:30 so notice when the price is dropping by 10 over here from 9 from 90 to 80 the amount demand is increasing from 100 to 200 right drop of 10 increases an increase in quantity made of 100 and when this drops by 10 from 20 to 10 this increase this increases from 800 to 900 all right so we're sliding along our demand curve over here and we're sliding along our demand curve over here so we want to talk about now is what is the elasticity when you go from 90 to 80 um
46:30 - 47:00 at the price of 90 to 80 and what's the last price elasticity of demand when you go from a price of 20 to 10 and you might think it's the same it's either an elastic demand curve in a la or a elastic demand curve but we're going to take a look at the math on that now because i want to try to show you um the elasticity how to calculate elasticity well we're already showing you how to calculate elasticity but how to show you the elasticity along a linear demand curve when we do the how it changes when we do the calculations so
47:00 - 47:30 we're going to use the demand curve we just we just drew so if you take a look the numbers are exactly the same when the price is 90 the quantum man's 100 when the price is 80 the quantity demanded is 200. the second problem that we're going to do if you notice numbers are exactly the same when the price is 20 quantum man's 800 when the price is 10. quantum and it is 900. that is to say that when price is changing by 10 either way quantum minute changes by 100 and again when price is changing by 10 down here quantum demand is changing by 100. it's a constant slope but is the elasticity
47:30 - 48:00 constant the answer is no it's not let's take a look why um so when we see the uh to figure out the percentage change in quantum demanded which is what we have to do to calculate elasticity um we see that the absolute change in it is 100 right um but to figure out percentage you have to divide by the base in order to figure out what's the percentage change so to take a look at that um remember the problems we did with the we had with the formula if you use 100 as a base you get one answer if you use 200 as the
48:00 - 48:30 base you get a different answer so we're going to pick the compromise point we're going to pick the midpoint which is i think most of you can see the midpoint between 100 200 is 150. to figure out technically mathematically you would do 100 plus 200 is equal to 300 divided by 2 is 150. all right so to figure out the percentage change in quantity demanded you take the 100 that was the absolute change between the two numbers you divide it by the base which in this case is 150 and you would get 67 so using
48:30 - 49:00 that midpoint formula the quantity demanded change by 67 do the same thing for price what's the absolute change in price it's an absolute change of 10. that's why we have 10 here but what do you divide by well we don't divide by 90 we don't divide by 80 we divide by that compromise choice the middle point which is 85 right and you can see you could get that by adding 90 plus 80 is 170 divided by 2 is 85. so the percentage change in price is 12
49:00 - 49:30 so notice i've labeled this as elastic the elasticity of demand is 5.6 that's elastic right anything over the number one is elastic and remember the other way we look at elasticity is something's elastic if the percentage change in quantity demanded is greater than the percentage change in the price which it clearly is here more than five times as much greater all right so it's elastic so we go from price of 90 to 80 or 80 to 90 we have an elastic demand it's responsive but let's take a look
49:30 - 50:00 down here which is again the same demand curve just that lower prices well when you do the percentage change in quantity demanded doing it the same way we did up here the quantity demanded the absolute change is 100 but you're not going to divide by 800 or 900 you can divide by that compromise choice which is 850. 100 divided by 850 is 12 percent so this is only a 12 percent change in quantum added again why is that the absolute change was 100 just like it was up here
50:00 - 50:30 but you're dividing by a larger base right so therefore it's not as significant a change it's a 12 change do the same thing for price what's the absolute change in price it's 10 but again you have to divide by the base we're not dividing by 20 we're not dividing by 10 we're going to divide by the compromised number which is 15. so you do 10 divided by 15 and you get a change of 67 again the price in both problems has only changed by ten dollars but the uh the base is different here you're dividing by a lot larger base
50:30 - 51:00 down here the one we're doing now you're dividing by a smaller base so you get a change of 67 percent notice percentage changes have flipped in this problem so what's the elasticity of demand when you do out this calculation turns out the elasticity demands approximately 17 percent now 17 excuse me uh just 0.17 again elastic or inelastic well that's going to be inelastic right anything where the elasticity is between zero and one we consider an inelastic demand not responsive or another way of looking at it the percentage change in the quantity
51:00 - 51:30 demanded was less than the percentage change in the price so that is inelastic okay so notice same dimensions label that is inelastic um same demand curve but at higher prices the demand tends to be elastic at lower prices it tends to be inelastic so i want to go back to the demand curve that i just graphed for you and we can discuss why this is the case okay looking back at the demand curve that we drew earlier we have the same points that we just
51:30 - 52:00 talked about right and so if you remember we just saw that when the price drops from 90 to 80 and the quant amount increases from 100 to 200 the elasticity when we went from here was 5.6 um 5.6 less elastic and then when we went from 20 to 10 the the quantum had increased from 800 to 900 which was a 0.17 elasticity highly inelastic so
52:00 - 52:30 again what you should see is as you move to the right along the demand curve the elasticity starts out as inelastic and then becomes more elastic now if you want a reason for this think of it this way if you remember one of the factors which affects the price elasticity of demand is the share of the budget right goods which have a larger share of uh household budget tend to be more elastic and goods which have a which are a smaller
52:30 - 53:00 percentage of the household budget tend to be inelastic so if you take a look um at the demand curve these prices are relatively high at least compared with these prices right and when prices are relatively high that tends to mean that it's going to be more elastic when prices tend to be low it tends to be inelastic so that might be another way of helping you look at it okay so what i just want to do next i just want to show you just a finished demand curve without all the numbers in here and we can talk about give you a clean look at elasticity along the demand curve
53:00 - 53:30 okay now just a quick look at the demand curve that we've been doing the linear demand curve if you take a look at my graph it's just basically what we've been what we've been showing the top half of the demand curve the demand tends to be more elastic as you move to the right along the demand curve it tends to get inelastic correct because um at higher prices goods tend to be a larger share of the household budget so then for the therefore they tend to be more elastic at lower prices
53:30 - 54:00 they're lower share the household budget therefore they tend to be more inelastic and again just mathematically speaking a drop in a price of 10 up here is a much smaller percentage than a drop in the price of 10 down here where you'll be dividing by a a smaller smaller base and vice versa for the for the quantity on toward the left-hand portion of the demand curve the percentage change in in the quantity is going to be a lot a lot greater
54:00 - 54:30 because you'll be dividing by a smaller base whereas over here or to the right it's going to be a lot smaller because you'll be dividing by uh by a larger base so that's just something that you need to know that demand is elasticity of demand is not consistent along a linear demand curve it's it's at higher prices it's elastic at lower prices it tends to be more inelastic