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

and its applications.
and its applications.

This is going to take us a few lectures
This is going to take us a few lectures

because the material is a little bit involved
because the material is a little bit involved

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

can be a little bit tedious.
can be a little bit tedious.

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

how to use and memorize and so forth.
how to use and memorize and so forth.

However, the applications are really fascinating.
However, the applications are really fascinating.

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

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

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

This is just another one of those foundational concepts
This is just another one of those foundational concepts

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

Let's get started.
Let's get started.

Demand curves slope down.
Demand curves slope down.

In other words, when the price goes up,
In other words, when the price goes up,

the quantity demanded goes down, when the price goes down,
the quantity demanded goes down, when the price goes down,

the quantity demanded goes up.
the quantity demanded goes up.

Pretty simple.
Pretty simple.

But how much does quantity demanded change
But how much does quantity demanded change

when the price changes?
when the price changes?

When the price goes down, does the quantity demanded
When the price goes down, does the quantity demanded

increase by a lot or by a little?
increase by a lot or by a little?

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

Here's the basic terminology.
Here's the basic terminology.

A demand curve is said to be elastic
A demand curve is said to be elastic

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

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

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

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

When the same increase in price reduces the quantity demanded
When the same increase in price reduces the quantity demanded

just a little or when the same decrease in price increases
just a little or when the same decrease in price increases

the quantity demanded just a little,
the quantity demanded just a little,

then the demand curve is said to be inelastic
then the demand curve is said to be inelastic

or less elastic or not elastic.
or less elastic or not elastic.

The elasticity of demand is going to be a measure
The elasticity of demand is going to be a measure

of how responsive the quantity demanded is
of how responsive the quantity demanded is

to a change in the price.
to a change in the price.

Here's an example.
Here's an example.

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

is an inelastic demand curve.
is an inelastic demand curve.

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

that the quantity demanded goes down by just a little,
that the quantity demanded goes down by just a little,

by five units from 80 units to 75 units.
by five units from 80 units to 75 units.

Now consider the following -- suppose we had
Now consider the following -- suppose we had

a demand curve like this.
a demand curve like this.

This turns out to be an elastic demand curve.
This turns out to be an elastic demand curve.

Notice that the same $10 increase in price now reduces
Notice that the same $10 increase in price now reduces

the quantity demanded from 80 units to 20 units.
the quantity demanded from 80 units to 20 units.

On the elastic demand curve, the quantity demanded
On the elastic demand curve, the quantity demanded

is much more responsive to the price than it is
is much more responsive to the price than it is

on the inelastic demand curve.
on the inelastic demand curve.

On a demand curve where the quantity demanded
On a demand curve where the quantity demanded

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

On a demand curve when the quantity demanded
On a demand curve when the quantity demanded

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

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

a less elastic demand.
a less elastic demand.

Now you may have noticed on the previous diagrams
Now you may have noticed on the previous diagrams

that the inelastic curve had the higher slope.
that the inelastic curve had the higher slope.

That is it was more vertical, while the elastic curve
That is it was more vertical, while the elastic curve

was the more horizontal curve.
was the more horizontal curve.

We haven't defined elasticity technically yet.
We haven't defined elasticity technically yet.

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

is not the same as slope.
is not the same as slope.

However, they are related.
However, they are related.

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

you're going to be fine.
you're going to be fine.

The rule is this -- if two linear demand
The rule is this -- if two linear demand

or supply curves run through a common point,
or supply curves run through a common point,

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

more horizontal, that's the more elastic curve.
more horizontal, that's the more elastic curve.

So if you're going to draw two demand curves
So if you're going to draw two demand curves

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

Let's say they run through a common point.
Let's say they run through a common point.

The flatter one is the more elastic curve,
The flatter one is the more elastic curve,

that will work fine for you.
that will work fine for you.

What determines whether a demand curve
What determines whether a demand curve

is more or less elastic?
is more or less elastic?

The key determinant is the availability
The key determinant is the availability

of substitutes.
of substitutes.

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

the more elastic the curve.
the more elastic the curve.

We can also give some more specific examples
We can also give some more specific examples

that are closely related to the number of substitutes.
that are closely related to the number of substitutes.

The time horizon -- a longer time horizon
The time horizon -- a longer time horizon

is going to make the curve more elastic.
is going to make the curve more elastic.

The category of product, a broad category
The category of product, a broad category

is going to be less elastic.
is going to be less elastic.

A specific category, more elastic.
A specific category, more elastic.

Necessities versus luxuries.
Necessities versus luxuries.

Luxuries are going to be more elastic.
Luxuries are going to be more elastic.

The purchase size -- bigger purchase sizes
The purchase size -- bigger purchase sizes

are going to be more elastic.
are going to be more elastic.

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

if you haven't followed them all right away.
if you haven't followed them all right away.

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

and explain the details.
and explain the details.

The availability of substitutes is really the key determinant
The availability of substitutes is really the key determinant

of how elastic a demand curve is.
of how elastic a demand curve is.

The idea is pretty intuitive.
The idea is pretty intuitive.

If there's lots of substitutes for a good,
If there's lots of substitutes for a good,

then when the price of that good goes up,
then when the price of that good goes up,

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

towards the substitutes.
towards the substitutes.

They're going to buy the substitutes instead.
They're going to buy the substitutes instead.

That means that when a good with lots of substitutes,
That means that when a good with lots of substitutes,

when the price of that good goes up,
when the price of that good goes up,

the quantity demanded is going to go down a lot
the quantity demanded is going to go down a lot

as people switch to the substitutes.
as people switch to the substitutes.

On the other hand, if we have a good
On the other hand, if we have a good

which has very few substitutes,
which has very few substitutes,

then consumers are going to find it harder to adjust
then consumers are going to find it harder to adjust

when the price has changed.
when the price has changed.

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

consumers aren't going to be able to switch
consumers aren't going to be able to switch

out of that good into another good.
out of that good into another good.

So the quantity demanded is going to remain fairly constant.
So the quantity demanded is going to remain fairly constant.

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

Let's test your understanding with some quick examples.
Let's test your understanding with some quick examples.

Oil, Brazilian coffee, insulin, Bayer Aspirin.
Oil, Brazilian coffee, insulin, Bayer Aspirin.

Which of these goods have an elastic demand?
Which of these goods have an elastic demand?

Which of them have an inelastic demand?
Which of them have an inelastic demand?

Let's start with oil.
Let's start with oil.

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

Just a few substitutes, right?
Just a few substitutes, right?

So if the price of oil goes up tomorrow,
So if the price of oil goes up tomorrow,

at that point do we all stop driving our cars?
at that point do we all stop driving our cars?

No, there aren't very many substitutes,
No, there aren't very many substitutes,

at least in the short run.
at least in the short run.

Few substitutes that means inelastic demand for oil.
Few substitutes that means inelastic demand for oil.

What about Brazilian coffee?
What about Brazilian coffee?

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

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

Therefore, lots of substitutes, therefore elastic demand.
Therefore, lots of substitutes, therefore elastic demand.

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

Not many substitutes, therefore inelastic demand.
Not many substitutes, therefore inelastic demand.

What about Bayer Aspirin?
What about Bayer Aspirin?

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

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

All kinds of generic aspirins.
All kinds of generic aspirins.

If you understand that aspirin is aspirin,
If you understand that aspirin is aspirin,

you'll understand that there are lots of substitutes.
you'll understand that there are lots of substitutes.

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

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

Therefore, elastic demand.
Therefore, elastic demand.

The time horizon influences the elasticity of demand
The time horizon influences the elasticity of demand

for a good.
for a good.

And really this is just an application of the fact
And really this is just an application of the fact

that the fundamental determinant is substitutes.
that the fundamental determinant is substitutes.

Immediately following a price increase,
Immediately following a price increase,

it's going to be difficult to find substitutes.
it's going to be difficult to find substitutes.

Therefore, immediately following a price increase, demand is likely
Therefore, immediately following a price increase, demand is likely

to be fairly inelastic, but over time consumers
to be fairly inelastic, but over time consumers

can adjust their behavior and they can find more substitutes.
can adjust their behavior and they can find more substitutes.

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

that there are very few substitutes in the short run.
that there are very few substitutes in the short run.

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

that people would do if the price of oil
that people would do if the price of oil

stays permanently higher?
stays permanently higher?

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

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

because for decades, the price of oil
because for decades, the price of oil

has been higher in Europe due to taxes.
has been higher in Europe due to taxes.

People have adjusted.
People have adjusted.

In the long run, people will even adjust
In the long run, people will even adjust

how cities are designed so that more people
how cities are designed so that more people

will live in apartments closer to where they work
will live in apartments closer to where they work

if the price of oil stays high.
if the price of oil stays high.

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

People will be more willing to live far away
People will be more willing to live far away

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

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

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

Another factor determining the elasticity of demand, again,
Another factor determining the elasticity of demand, again,

based upon the fundamental question:
based upon the fundamental question:

are there lots of substitutes or just a few
are there lots of substitutes or just a few

is what we might call the classification of the good.
is what we might call the classification of the good.

The broader the classification, the less likely consumers
The broader the classification, the less likely consumers

will be able to find a substitute.
will be able to find a substitute.

The narrower the classification, the more likely consumers
The narrower the classification, the more likely consumers

will be able to find a substitute.
will be able to find a substitute.

We've already seen an example of this.
We've already seen an example of this.

There are more substitutes for Bayer Aspirin,
There are more substitutes for Bayer Aspirin,

a narrow classification, than there are for aspirin,
a narrow classification, than there are for aspirin,

a wider classification.
a wider classification.

If the price of Bayer Aspirin goes up,
If the price of Bayer Aspirin goes up,

there are more substitutes -- the generics.
there are more substitutes -- the generics.

If the price of all aspirin goes up,
If the price of all aspirin goes up,

there are fewer substitutes.
there are fewer substitutes.

Of course, there are still some, like ibuprofen
Of course, there are still some, like ibuprofen

and acetaminophen and so forth.
and acetaminophen and so forth.

But the narrower the classification,
But the narrower the classification,

the more substitutes, the more elastic the demand.
the more substitutes, the more elastic the demand.

Another example, the demand for food.
Another example, the demand for food.

A broad classification is less elastic
A broad classification is less elastic

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

a narrow classification.
a narrow classification.

Therefore the demand for lettuce would be more elastic
Therefore the demand for lettuce would be more elastic

than the demand for food.
than the demand for food.

The nature of the good in the consumer's mind
The nature of the good in the consumer's mind

can also affect the elasticity.
can also affect the elasticity.

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

or as a luxury.
or as a luxury.

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

in the world.
in the world.

They are more about a person's tastes.
They are more about a person's tastes.

For example, for some consumers that coffee in the morning
For example, for some consumers that coffee in the morning

is a necessity.
is a necessity.

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

those consumers will still continue to consume
those consumers will still continue to consume

about the same amount of coffee.
about the same amount of coffee.

Therefore, those consumers will have an inelastic demand.
Therefore, those consumers will have an inelastic demand.

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

to be necessities.
to be necessities.

The same good in someone else's mind
The same good in someone else's mind

might be a luxury.
might be a luxury.

The consumer who occasionally has a cup of coffee.
The consumer who occasionally has a cup of coffee.

If the price goes up,
If the price goes up,

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

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

to something else."
to something else."

Depending upon how consumers regard the good therefore
Depending upon how consumers regard the good therefore

as a necessity, more inelastic demand.
as a necessity, more inelastic demand.

As a luxury, more elastic demand.
As a luxury, more elastic demand.

The final determinant is the size of the purchase
The final determinant is the size of the purchase

relative to a consumer's budget.
relative to a consumer's budget.

If the purchase is small relative to the budget,
If the purchase is small relative to the budget,

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

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

with a big change in the quantity demanded.
with a big change in the quantity demanded.

On the other hand, if we have a product
On the other hand, if we have a product

which is a large part of the budget,
which is a large part of the budget,

consumers will notice.
consumers will notice.

Consumers notice when the price of automobiles goes up --
Consumers notice when the price of automobiles goes up --

that's a big purchase.
that's a big purchase.

They're going to shop around a lot.
They're going to shop around a lot.

They're going to try and get a big bargain
They're going to try and get a big bargain

when the purchase is a large fraction
when the purchase is a large fraction

of their budget.
of their budget.

On the other hand, when the price of toothpicks
On the other hand, when the price of toothpicks

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

Consumers probably won't even notice
Consumers probably won't even notice

whether toothpicks are $0.50 or a $1.
whether toothpicks are $0.50 or a $1.

That's a 50% increase in price,
That's a 50% increase in price,

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

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

Bigger items, the bigger part of the budget,
Bigger items, the bigger part of the budget,

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

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

For less elastic goods, that means fewer substitutes.
For less elastic goods, that means fewer substitutes.

Short run, less time to adjust, necessities,
Short run, less time to adjust, necessities,

small part of the budget.
small part of the budget.

Each of these factors makes the demand curve less elastic.
Each of these factors makes the demand curve less elastic.

More elastic demand, that means more substitutes.
More elastic demand, that means more substitutes.

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

These factors make a demand curve more elastic.
These factors make a demand curve more elastic.

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

that elasticity means how responsive
that elasticity means how responsive

is the quantity demanded to a change in the price,
is the quantity demanded to a change in the price,

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

That's it for the elasticity of demand.
That's it for the elasticity of demand.

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

how do we get a number?
how do we get a number?

How do we calculate the elasticity of demand?
How do we calculate the elasticity of demand?

Given some facts and figures on prices and quantity demanded,
Given some facts and figures on prices and quantity demanded,

how do we calculate what the elasticity really is?
how do we calculate what the elasticity really is?

What's the number?
What's the number?

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

click Practice questions.
click Practice questions.

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

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