Economics Micro & Macro (CliffsAP)

Part III: Microeconomics

however, you elect to lower your price for pizza to increase sales. The problem is that you don’t know just how much
you should lower it. Should you go from $1.50 to $1.25, or should you just make it an even $1.00? The answer depends
on how consumers are responding to a price change. Economists have devised measures that reveal how much con-
sumers alter their purchases in response to price changes. These measures are called elasticities.

The price elasticity of demandis a measure of the responsiveness by which consumers alter their quantity demanded
due to a change in price. The more price elastic demand is, the more responsive consumers are to a price change. On
the other hand, the less price elastic demand is, the less responsive consumers are to a price change. The price elasticity
of demand is the percentage change in quantity demanded divided by the percentage change in price:

Price elasticity % Change in price

% Quantity demanded

=

For instance, if the quantity demanded for pizza falls 3 percent, every time the price of pizza goes up 1 percent, then
we know that the elasticity of demand is 3. Based on this answer, we can state that the demand for this pizza is elastic.
When trying to determine this answer, we sometimes have to deal with negative numbers. Whenever you’re faced with
a negative number, you should drop the negative sign and take the absolute value of the number. Absolute values help
us clear out some of the confusion when dealing with elasticities.

Demand can be elastic, unitary elastic, or inelastic. When the answer to the elasticity formula is greater than 1, a prod-
uct is elastic in demand. This means that when the price of the good is increased, there will be a significant response in
the quantity demanded for that product. When demand for a good is inelastic, the elasticity formula reveals an answer
that is below 1. This means that a change in price will not have a significant impact on the quantity demanded for that
product. When the formula reveals an answer of 1, it means that demand is unitary elastic; a change in price is equiva-
lent to the change in quantity demanded.

Demand Curves and Elasticity

A perfectly elastic demand curve is illustrated by a horizontal line stretching from the price axis outward. This means
that consumers will buy any quantity desired at one price. This is illustrated in Figure 7-1.

Figure 7-1

An example is the demand for wheat. A wheat farmer is only one producer who makes a product identical to that of his
competition. Because he is just one among many and sells an identical product, the wheat farmer cannot charge any-
thing but the market price for his product. If he sets his price too low, competitors will follow and revenue will be lost.
If he chooses to increase his price, his customers will go to competitors. A perfectly elastic demand means that even the
smallest change in price will have a significant impact on the quantity demanded.

Quantity

Demanded

Market

Price

Price