Elasticity of Demand- Micro Topic 2.3 - Hey, how you doing, Econ students? This is Mr. Clifford. Welcome to ACDC Econ. Right now, I'm going to talk about elasticity. [THEME MUSIC] You already know the law of demand says there's an inverse relationship between price and quantity. So when the price goes up for a product, people buy less. When the price goes down, people buy more. But the question now is, how much less or how much more do they buy? And that's the idea of elasticity. Elasticity shows how sensitive quantity is to a change in price. What happens to quantity when there's a change in price depends a lot on the type of product. First, we're going to talk about the idea of inelastic. (FUNNY VOICE) Inelastic. Let's talk about gasoline. Gasoline has inelastic demand. This means when there's an increase in the price of gasoline, the quantity demanded decreases, but just a little bit. So when the demand is inelastic, the quantity is insensitive to a change in price. And it goes the other direction. When the price falls, the quantity demanded goes up-- but just a little bit. You don't jump in your car when the price goes down and rev your engine-- [REVVING ENGINE SOUND] and run stop signs. That's not what you do. So when the price goes down, you buy a little bit more. When the price goes up, you buy a little bit less. Insensitive to a change in price. The reason for this is because products that have inelastic demand have very few substitutes. When it comes to gasoline, there's nothing else I can put in my car. And God knows I'm not walking. I'm an American. That was a joke to all of you guys who are environmentalists. I apologize. I don't want to hurt your feelings. I love trees. I will hug one. (CRYING) I love you. I love you so much. In addition to having few substitutes, gasoline is also a necessity and it has an elasticity coefficient that is less than 1. Whoa, coefficients-- no math. Can stand math. Listen, there's going to be a little bit of math in microeconomics. But it's nothing crazy. One of the things you got to watch out for is freaking out when you hear things like coefficient. It's not that hard. The elasticity of demand coefficient is the percent change in quantity divided by the percent change in price, which is not hard at all. All it's trying to say is that when there is a small change in quantity, when there's a big change in price, this number is less than 1. And if it's less than 1, it's inelastic demand. Real quick, we're talking about absolute value. Remember, when the price goes up, the quantity always goes down. So we're talking about the absolute value of the elasticity of demand coefficient. The point is, when there's inelastic demand, the quantity is insensitive to a change in price. So what if demand is elastic? (FUNNY VOICE) Elastic. That means quantity is sensitive to a change in price. So right here, when the price goes up, the quantity decreases a whole lot. And when the price goes down, the quantity demanded goes up a whole lot. So when the demand is elastic, it means that these products have many substitutes, or they're luxuries, or they have an elasticity coefficient greater than 1-- a big change in quantity as a result of a small change in price. Now, what if the percent change in quantity is exactly equal to the percent change in price? Well, that's something called unit elastic. Unit elastic is the idea that if the price goes up 20% and the quantity goes down 20%, this pops out a 1. A 1 means unit elastic. What if the demand is a vertical straight line, or something called perfectly inelastic? Well, that means an increase in price has no effect on quantity. Quantity doesn't change. So the percent change in quantity is zero whenever there's a percent change in price. And so the elasticity of demand coefficient is zero. That's the idea, perfectly inelastic. And if the demand curve is horizontal, where a firm cannot change the price at all-- if they change the price, no one's going to buy-- that would mean that the elasticity of demand coefficient will be infinite. All of this will make more sense when you see them side by side, so take a look at this. What you're looking at is five different demand curves-- perfectly inelastic, relatively inelastic, unit elastic, relatively elastic, and perfectly elastic. And you can see the elasticity coefficient is 0, less than 1, 1, greater than 1, and infinite. This shows you the more substitutes a product has and the more sensitive it is to a change in price, the greater the elasticity of demand coefficient. Does it make sense? Bonus round. One of the most important topics you're going to see is something called the total revenue test. So this tells you what happens to total revenue when there's a change in price if the demand curve is inelastic or elastic. It will make more sense on a graph. Over here on the left we have inelastic demand. Right here on the right, we have elastic demand. The total revenue is the price times the quantity. It's this box right here. Notice how the box on both graphs starts exactly the same size. When supply shifts to the left, that causes the price to go up. Notice that on both curves, the price goes up and the quantity goes down. Remember, the law of demand is at play here. When the price goes up, the quantity goes down. We're not analyzing that. What we're analyzing is the total revenue, the size of the box. So for inelastic demand, the price went up a whole lot. But quantity decreased just a little bit. And so the size of the box got bigger. That means, when the demand's inelastic, the price goes up and the total revenue goes up. Or when the price goes down, the total revenue goes down. And that explains why gas stations never have sales. There's no reason for a gas station to have, like, a half-off gas sale because if they lower their price, the total revenue is not going to increase. But let's take a look at elastic demand. When the price goes up, a whole lot of people don't want to buy it. And so the size of the total revenue box gets smaller. So when the price goes up, total revenue falls. And when the price goes down, total revenue goes up. That's why products that have elastic demand will have sales all the time. Now, what you're going to see on a test is a question that says, if there's a given product, product x, and the price goes up, and the total revenue goes down, what must be true? And the answer is, it's elastic demand. If the price goes up and the total revenue, the box, gets smaller, that's elastic demand. (EXCITEDLY) Bonus, bonus round. One of the things I do to help students understand the total revenue test is giving this thing to do with their hands. So as the price goes up for a product and the total revenue goes up, I look like an I. If I look like an I, the demand is inelastic. Price goes up. Total revenue goes up. The other way to look like an I is if price goes down and total revenue goes down. I look like an I. I'm inelastic demand. If the price goes up and total revenue goes down, I don't look like an I. I'm elastic demand. If price goes down and total revenue goes up, I'm not an I. It must be elastic demand. So this is going to help going to test. If they say the price goes up for products and the total revenue went up, you look at yourself, you look like an I, inelastic demand. I hope this video helped you understand the idea of elasticity and the total revenue test. Now, make sure to subscribe and take a look at the next video that's going to explain cross price and income elasticity. Also, check out my series of videos called "Econ Movies." All right, till next time.