5 Steps to a 5 AP Microeconomics, 2014-2015 Edition

• In general, the more vertical a good’s demand curve (D 0 ), the more inelastic the
  demand for that good.


• The more horizontal a good’s demand curve (D 1 ), the more elastic the demand for that
  good.


• Despite this generalization, be careful; elasticity and slope are notequivalent measures.

Determinants of Elasticity

Perfectly elastic and perfectly inelastic demand curves are usually reserved for the hypothetical

example, but they illustrate that Eddiffers across consumer goods. Your intuition is that con-

sumers respond to a price change in different ways. A 10 percent increase in the price of a car

might have a drastically different consumer response from what we observe from a 10 percent

increase in the price of a college education, a package of mechanical pencils, or a hotel stay in

Fort Lauderdale. Let’s look at some general explanations for why elasticity differs.

1. Number of Good Substitutes

If the price of good X increases, and many substitutes exist, the decrease in quantity

demanded can be quite elastic. For this reason, we expect Edof orange juice to be high,

since there are many substitutes available to drinkers of fruit juice.

Corollary.Oftentimes you hear of a good that is a “necessity” or a “frivolity.” These

adjectives are reiterating a relative lack of or a relative wealth of good substitutes.

Example:

The more narrowly the product is defined, the more elastic it becomes. If we narrow

our focus from orange juice down to one brand of orange juice (e.g., Minute

Maid), the number of substitutes grows and we predict that so too does the price

elasticity of demand for Minute Maid brand orange juice. Likewise, the demand

for blue Chevrolet SUVs is more elastic than the demand for Chevrolet SUVs,

which, in turn, is more elastic than the demand for all SUVs.

2. Proportion of Income

If the price of a good increases, the consumer loses purchasing power. If that good takes

up a large proportion of the consumer’s income, he greatly feels the pinch of the income

effect, and his responsiveness might be significant. If the price of toothpicks increased

by 10 percent, the typical household probably would not feel the lost purchasing power

and Edwould be low. The opposite would be true if the price of food items increased

by 10 percent.

Example:

A young full-time college student is purchasing her education by the credit-hour

and supporting herself with a part-time job on the weekends and evenings.

Since the student is living on a relatively small monthly income, if the price of

a credit-hour increases, the response might be very elastic. The student might

drop down to part-time status or drop out of college altogether so that she can

save enough money to return next quarter.

3. Time

Consumers faced by a rising price are usually fairly resourceful in their ability to find a

way of decreasing the quantity demanded of a good. The difficulty faced by consumers

is that they might not have time, at least not initially, to find a substitute for the more

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