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- [Alex] Today, we begin[br]to discuss elasticity

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and its applications.

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This is going to take us[br]a few lectures

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because the material[br]is a little bit involved

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and also, I'm going to be honest,[br]the material

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can be a little bit tedious.

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There's some formulas[br]that we're going to have to learn

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how to use and memorize[br]and so forth.

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However, the applications[br]are really fascinating.

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Moreover, elasticity is going[br]to come back again and again.

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We're going to use it[br]when we do taxes and subsidies,

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we're going to use it again[br]when we do monopoly.

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This is just another one[br]of those foundational concepts

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that is going to pay to learn well[br]the first time we do it.

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Let's get started.

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Demand curves slope down.

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In other words,[br]when the price goes up,

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the quantity demanded goes down,[br]when the price goes down,

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the quantity demanded goes up.

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Pretty simple.

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But how much does quantity[br]demanded change

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when the price changes?

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When the price goes down,[br]does the quantity demanded

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increase by a lot or by a little?

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That's the concept that elasticity[br]is going to help us to understand.

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Here's the basic terminology.

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A demand curve is said[br]to be elastic

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when an increase in price reduces[br]the quantity demanded by a lot.

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And similarly, when a decrease in price[br]increases the quantity demanded

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by a lot -- that's an elastic curve.

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The quantity is changing a lot[br]in response to the price.

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When the same increase in price[br]reduces the quantity demanded

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just a little or when the same[br]decrease in price increases

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the quantity demanded[br]just a little,

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then the demand curve[br]is said to be inelastic

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or less elastic or not elastic.

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The elasticity of demand[br]is going to be a measure

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of how responsive[br]the quantity demanded is

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to a change in the price.

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Here's an example.

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Let's start with this demand curve[br]which we're going to see

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is an inelastic demand curve.

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Notice that when the price[br]increases from $40 to $50

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that the quantity demanded[br]goes down by just a little,

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by five units from 80 units[br]to 75 units.

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Now consider the following --[br]suppose we had

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a demand curve like this.

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This turns out to be[br]an elastic demand curve.

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Notice that the same $10 increase[br]in price now reduces

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the quantity demanded[br]from 80 units to 20 units.

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On the elastic demand curve,[br]the quantity demanded

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is much more responsive[br]to the price than it is

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on the inelastic demand curve.

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On a demand curve[br]where the quantity demanded

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is responsive to the price,[br]that's called an elastic demand.

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On a demand curve[br]when the quantity demanded

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isn't responsive[br]or is less responsive to the price,

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that's an inelastic demand[br]or a more inelastic demand,

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a less elastic demand.

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Now you may have noticed[br]on the previous diagrams

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that the inelastic curve[br]had the higher slope.

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That is it was more vertical,[br]while the elastic curve

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was the more horizontal curve.

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We haven't defined elasticity[br]technically yet.

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When we do so, you'll be able[br]to see that elasticity

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is not the same as slope.

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However, they are related.

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For the purposes of this class,[br]if you follow a simple rule,

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you're going to be fine.

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The rule is this --[br]if two linear demand

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or supply curves run through[br]a common point,

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then at any given quantity,[br]the curve that is flatter,

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more horizontal,[br]that's the more elastic curve.

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So if you're going to draw[br]two demand curves

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which we're going to have[br]to do many times in this class.

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Let's say they run[br]through a common point.

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The flatter one is[br]the more elastic curve,

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that will work fine for you.

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What determines[br]whether a demand curve

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is more or less elastic?

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The key determinant[br]is the availability

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of substitutes.

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As we'll see in a minute,[br]the more substitutes,

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the more elastic the curve.

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We can also give[br]some more specific examples

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that are closely related[br]to the number of substitutes.

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The time horizon --[br]a longer time horizon

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is going to make the curve[br]more elastic.

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The category of product,[br]a broad category

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is going to be less elastic.

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A specific category, more elastic.

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Necessities versus luxuries.[br]

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Luxuries are going[br]to be more elastic.

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The purchase size -- [br]bigger purchase sizes

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are going to be more elastic.

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Now I've gone through those quickly[br]so don't worry

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if you haven't followed them[br]all right away.

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I'm going to go through them,[br]now, each in turn

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and explain the details.

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The availability of substitutes[br]is really the key determinant

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of how elastic a demand curve is.

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The idea is pretty intuitive.

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If there's lots of substitutes[br]for a good,

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then when the price[br]of that good goes up,

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people are going to switch from it,[br]the good whose price is increased,

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towards the substitutes.

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They're going to buy[br]the substitutes instead.

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That means that when a good[br]with lots of substitutes,

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when the price[br]of that good goes up,

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the quantity demanded[br]is going to go down a lot

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as people switch[br]to the substitutes.

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On the other hand,[br]if we have a good

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which has very few substitutes,

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then consumers are going[br]to find it harder to adjust

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when the price has changed.

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In particular, if the price goes up[br]and there are very few substitutes,

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consumers aren't going[br]to be able to switch

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out of that good[br]into another good.

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So the quantity demanded[br]is going to remain fairly constant.

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It's not going to fall a lot[br]when the good has few substitutes.

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Let's test your understanding[br]with some quick examples.

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Oil, Brazilian coffee, insulin,[br]Bayer Aspirin.

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Which of these goods[br]have an elastic demand?

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Which of them have[br]an inelastic demand?

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Let's start with oil.

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Are there lots of substitutes[br]for oil or just a few substitutes?

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Just a few substitutes, right?

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So if the price of oil[br]goes up tomorrow,

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at that point do we all stop[br]driving our cars?

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No, there aren't[br]very many substitutes,

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at least in the short run.

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Few substitutes that means[br]inelastic demand for oil.

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What about Brazilian coffee?

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Some people love Brazilian coffee[br]but there's also Ethiopian coffee,

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there's Mexican coffee,[br]there's Guatemalan coffee.

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Therefore, lots of substitutes,[br]therefore elastic demand.

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Insulin, if you don't get it[br]you're going to die.

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Not many substitutes,[br]therefore inelastic demand.

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What about Bayer Aspirin?

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If you go to Wal-Mart,[br]you'll find Wal-Mart Aspirin.

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If you go to Target,[br]there's Target Aspirin.

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All kinds of generic aspirins.

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If you understand[br]that aspirin is aspirin,

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you'll understand that there[br]are lots of substitutes.

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If Bayer tries to raise the price[br]of its aspirin too much,

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you'll say, "Forget it. I'm going[br]to go buy the substitutes."

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Therefore, elastic demand.

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The time horizon influences[br]the elasticity of demand

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for a good.

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And really this is just[br]an application of the fact

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that the fundamental determinant[br]is substitutes.

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Immediately following[br]a price increase,

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it's going to be difficult[br]to find substitutes.

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Therefore, immediately following[br]a price increase, demand is likely

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to be fairly inelastic,[br]but over time consumers

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can adjust their behavior[br]and they can find more substitutes.

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For example, if the price of oil[br]goes up, then we know

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that there are very few substitutes[br]in the short run.

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But in the long run,[br]what are some of the things

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that people would do[br]if the price of oil

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stays permanently higher?

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We'll drive smaller cars.[br]They'll switch to mopeds.

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There's a lot more mopeds[br]driven in Europe, for example,

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because for decades,[br]the price of oil

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has been higher in Europe[br]due to taxes.

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People have adjusted.

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In the long run,[br]people will even adjust

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how cities are designed[br]so that more people

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will live in apartments[br]closer to where they work

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if the price of oil stays high.

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If the price of oil is really low,[br]there'll be more sprawl.

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People will be more willing[br]to live far away

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and have a big lawn[br]if the price of oil isn't so high.

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The longer the time horizon,[br]the more the ability to adjust,

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the more substitutes, and thus,[br]the more elastic the demand.

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Another factor determining[br]the elasticity of demand, again,

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based upon[br]the fundamental question:

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are there lots of substitutes[br]or just a few

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is what we might call[br]the classification of the good.

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The broader the classification,[br]the less likely consumers

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will be able to find a substitute.

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The narrower the classification,[br]the more likely consumers

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will be able to find a substitute.

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We've already seen[br]an example of this.

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There are more substitutes[br]for Bayer Aspirin,

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a narrow classification,[br]than there are for aspirin,

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a wider classification.

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If the price[br]of Bayer Aspirin goes up,

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there are more substitutes --[br]the generics.

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If the price[br]of all aspirin goes up,

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there are fewer substitutes.

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Of course, there are still some,[br]like ibuprofen

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and acetaminophen and so forth.

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But the narrower[br]the classification,

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the more substitutes,[br]the more elastic the demand.

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Another example,[br]the demand for food.

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A broad classification[br]is less elastic

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than the demand for lettuce,[br]a particular type of food,

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a narrow classification.

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Therefore the demand[br]for lettuce would be more elastic

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than the demand for food.

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The nature of the good[br]in the consumer's mind

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can also affect the elasticity.

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In particular, whether the good[br]is thought of as a necessity

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or as a luxury.

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Now don't take these categories[br]as somehow being out there

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in the world.

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They are more[br]about a person's tastes.

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For example, for some consumers[br]that coffee in the morning

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is a necessity.

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Even if the price of coffee[br]goes up by a lot,

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those consumers[br]will still continue to consume

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about the same amount of coffee.

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Therefore, those consumers[br]will have an inelastic demand.

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They'll have an inelastic demand[br]for goods that they consider

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to be necessities.

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The same good[br]in someone else's mind

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might be a luxury.

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The consumer who occasionally[br]has a cup of coffee.

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If the price goes up,

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then they're going[br]to be more willing to say,

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"Nah, I'm going to switch to tea.[br]I'm going to switch

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to something else."

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Depending upon how consumers[br]regard the good therefore

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as a necessity,[br]more inelastic demand.

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As a luxury, more elastic demand.

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The final determinant[br]is the size of the purchase

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relative to a consumer's budget.

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If the purchase is small relative[br]to the budget,

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then consumers may not even notice[br]when the price goes up.

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And if they don't notice,[br]they're not going to respond

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with a big change[br]in the quantity demanded.

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On the other hand,[br]if we have a product

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which is a large part[br]of the budget,

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consumers will notice.

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Consumers notice when the price[br]of automobiles goes up --

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that's a big purchase.

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They're going to shop around a lot.

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They're going to try[br]and get a big bargain

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when the purchase[br]is a large fraction

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of their budget.

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On the other hand,[br]when the price of toothpicks

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goes up by a lot,[br]that's not such a big deal.

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Consumers probably[br]won't even notice

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whether toothpicks[br]are $0.50 or a $1.

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That's a 50% increase in price,

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but you probably don't even notice[br]that at the store.

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So small item at least[br]in the short run more inelastic.

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Bigger items, the bigger part[br]of the budget,

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ones the consumer notices,[br]more elastic, more price sensitive.

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Let's summarize the determinants[br]of the elasticity of demand.

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For less elastic goods,[br]that means fewer substitutes.

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Short run, less time to adjust,[br]necessities,

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small part of the budget.

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Each of these factors makes[br]the demand curve less elastic.

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More elastic demand,[br]that means more substitutes.

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Long run, more time to adjust.[br]Luxuries, large part of the budget.

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These factors make[br]a demand curve more elastic.

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If you have to, memorize these,[br]but once you understand

0:12:52.743,0:12:55.272
that elasticity means[br]how responsive

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is the quantity demanded[br]to a change in the price,

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then you'll be able to recreate[br]or figure out these factors again.

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That's it for the elasticity[br]of demand.

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Next time,we're going to take[br]a closer look at technically

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how do we get a number?

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How do we calculate[br]the elasticity of demand?

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Given some facts and figures[br]on prices and quantity demanded,

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how do we calculate[br]what the elasticity really is?

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What's the number?

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- [Narrator] If you want[br]to test yourself,

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click Practice questions.

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Or if you're ready to move on,[br]just click Next Video.

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♪ [music] ♪