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♪ [music] ♪

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- [Alex] Today, we begin
to discuss elasticity

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and its applications.

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This is going to take us
a few lectures

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because the material
is a little bit involved

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

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can be a little bit tedious.

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

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how to use and memorize
and so forth.

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However, the applications
are really fascinating.

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Moreover, elasticity is going
to come back again and again.

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

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

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This is just another one
of those foundational concepts

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that is going to pay to learn well
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,
when the price goes up,

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the quantity demanded goes down,
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
demanded change

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when the price changes?

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When the price goes down,
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
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
to be elastic

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

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And similarly, when a decrease in price
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
in response to the price.

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When the same increase in price
reduces the quantity demanded

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just a little or when the same
decrease in price increases

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the quantity demanded
just a little,

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then the demand curve
is said to be inelastic

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or less elastic or not elastic.

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The elasticity of demand
is going to be a measure

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of how responsive
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
which we're going to see

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is an inelastic demand curve.

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Notice that when the price
increases from $40 to $50

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that the quantity demanded
goes down by just a little,

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by five units from 80 units
to 75 units.

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Now consider the following --
suppose we had

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a demand curve like this.

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This turns out to be
an elastic demand curve.

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Notice that the same $10 increase
in price now reduces

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the quantity demanded
from 80 units to 20 units.

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On the elastic demand curve,
the quantity demanded

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is much more responsive
to the price than it is

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on the inelastic demand curve.

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On a demand curve
where the quantity demanded

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

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On a demand curve
when the quantity demanded

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isn't responsive
or is less responsive to the price,

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that's an inelastic demand
or a more inelastic demand,

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a less elastic demand.

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Now you may have noticed
on the previous diagrams

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that the inelastic curve
had the higher slope.

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That is it was more vertical,
while the elastic curve

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was the more horizontal curve.

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We haven't defined elasticity
technically yet.

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When we do so, you'll be able
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,
if you follow a simple rule,

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you're going to be fine.

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The rule is this --
if two linear demand

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or supply curves run through
a common point,

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then at any given quantity,
the curve that is flatter,

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more horizontal,
that's the more elastic curve.

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So if you're going to draw
two demand curves

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

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Let's say they run
through a common point.

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The flatter one is
the more elastic curve,

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that will work fine for you.

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What determines
whether a demand curve

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is more or less elastic?

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The key determinant
is the availability

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of substitutes.

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

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the more elastic the curve.

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We can also give
some more specific examples

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that are closely related
to the number of substitutes.

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The time horizon --
a longer time horizon

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is going to make the curve
more elastic.

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The category of product,
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.


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Luxuries are going
to be more elastic.

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The purchase size -- 
bigger purchase sizes

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are going to be more elastic.

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

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if you haven't followed them
all right away.

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

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and explain the details.

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The availability of substitutes
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
for a good,

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then when the price
of that good goes up,

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

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towards the substitutes.

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They're going to buy
the substitutes instead.

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That means that when a good
with lots of substitutes,

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when the price
of that good goes up,

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the quantity demanded
is going to go down a lot

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as people switch
to the substitutes.

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On the other hand,
if we have a good

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which has very few substitutes,

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then consumers are going
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
and there are very few substitutes,

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consumers aren't going
to be able to switch

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out of that good
into another good.

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So the quantity demanded
is going to remain fairly constant.

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

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Let's test your understanding
with some quick examples.

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Oil, Brazilian coffee, insulin,
Bayer Aspirin.

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Which of these goods
have an elastic demand?

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Which of them have
an inelastic demand?

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Let's start with oil.

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Are there lots of substitutes
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
goes up tomorrow,

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at that point do we all stop
driving our cars?

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No, there aren't
very many substitutes,

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at least in the short run.

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Few substitutes that means
inelastic demand for oil.

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What about Brazilian coffee?

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

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there's Mexican coffee,
there's Guatemalan coffee.

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Therefore, lots of substitutes,
therefore elastic demand.

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

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Not many substitutes,
therefore inelastic demand.

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What about Bayer Aspirin?

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

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If you go to Target,
there's Target Aspirin.

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All kinds of generic aspirins.

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If you understand
that aspirin is aspirin,

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you'll understand that there
are lots of substitutes.

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

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

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Therefore, elastic demand.

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The time horizon influences
the elasticity of demand

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for a good.

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And really this is just
an application of the fact

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that the fundamental determinant
is substitutes.

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Immediately following
a price increase,

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it's going to be difficult
to find substitutes.

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Therefore, immediately following
a price increase, demand is likely

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to be fairly inelastic,
but over time consumers

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can adjust their behavior
and they can find more substitutes.

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

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that there are very few substitutes
in the short run.

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But in the long run,
what are some of the things

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that people would do
if the price of oil

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stays permanently higher?

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We'll drive smaller cars.
They'll switch to mopeds.

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

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because for decades,
the price of oil

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has been higher in Europe
due to taxes.

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People have adjusted.

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In the long run,
people will even adjust

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how cities are designed
so that more people

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will live in apartments
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,
there'll be more sprawl.

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People will be more willing
to live far away

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

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The longer the time horizon,
the more the ability to adjust,

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the more substitutes, and thus,
the more elastic the demand.

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Another factor determining
the elasticity of demand, again,

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based upon
the fundamental question:

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are there lots of substitutes
or just a few

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is what we might call
the classification of the good.

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The broader the classification,
the less likely consumers

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will be able to find a substitute.

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The narrower the classification,
the more likely consumers

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will be able to find a substitute.

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We've already seen
an example of this.

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There are more substitutes
for Bayer Aspirin,

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a narrow classification,
than there are for aspirin,

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a wider classification.

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If the price
of Bayer Aspirin goes up,

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there are more substitutes --
the generics.

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If the price
of all aspirin goes up,

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there are fewer substitutes.

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Of course, there are still some,
like ibuprofen

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and acetaminophen and so forth.

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But the narrower
the classification,

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the more substitutes,
the more elastic the demand.

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Another example,
the demand for food.

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A broad classification
is less elastic

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than the demand for lettuce,
a particular type of food,

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a narrow classification.

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Therefore the demand
for lettuce would be more elastic

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than the demand for food.

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The nature of the good
in the consumer's mind

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can also affect the elasticity.

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

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or as a luxury.

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

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in the world.

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They are more
about a person's tastes.

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For example, for some consumers
that coffee in the morning

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is a necessity.

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

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those consumers
will still continue to consume

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about the same amount of coffee.

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Therefore, those consumers
will have an inelastic demand.

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

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to be necessities.

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The same good
in someone else's mind

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might be a luxury.

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The consumer who occasionally
has a cup of coffee.

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If the price goes up,

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then they're going
to be more willing to say,

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"Nah, I'm going to switch to tea.
I'm going to switch

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to something else."

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Depending upon how consumers
regard the good therefore

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as a necessity,
more inelastic demand.

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As a luxury, more elastic demand.

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The final determinant
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
to the budget,

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

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

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with a big change
in the quantity demanded.

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On the other hand,
if we have a product

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which is a large part
of the budget,

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consumers will notice.

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Consumers notice when the price
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
and get a big bargain

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when the purchase
is a large fraction

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of their budget.

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On the other hand,
when the price of toothpicks

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

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Consumers probably
won't even notice

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whether toothpicks
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
that at the store.

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

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Bigger items, the bigger part
of the budget,

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ones the consumer notices,
more elastic, more price sensitive.

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Let's summarize the determinants
of the elasticity of demand.

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For less elastic goods,
that means fewer substitutes.

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Short run, less time to adjust,
necessities,

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00:12:29,648 --> 00:12:31,493
small part of the budget.

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Each of these factors makes
the demand curve less elastic.

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More elastic demand,
that means more substitutes.

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00:12:39,982 --> 00:12:45,321
Long run, more time to adjust.
Luxuries, large part of the budget.

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These factors make
a demand curve more elastic.

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If you have to, memorize these,
but once you understand

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that elasticity means
how responsive

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is the quantity demanded
to a change in the price,

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

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That's it for the elasticity
of demand.

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

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how do we get a number?

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How do we calculate
the elasticity of demand?

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Given some facts and figures
on prices and quantity demanded,

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how do we calculate
what the elasticity really is?

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What's the number?

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- [Narrator] If you want
to test yourself,

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click Practice questions.

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

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♪ [music] ♪