Chapter in a Nutshell

When economists use the word elasticity, they mean sensitivity. Price elasticity of demand is a measure of buyers' sensitivity to price changes. The elasticity of demand to price changes varies among different categories of goods. The reasons for this variation in elasticity are explored in the chapter. The price elasticity of demand can be calculated as the ratio of percentage change in quantity demanded to the percentage change in price. Cross elasticity of demand is the percentage change in quantity demanded for one good divided by the percentage change in price of another good. Price elasticity of supply can also be measured. Supply becomes more sensitive to price changes given a longer time frame. The market-day supply is totally insensitive, or inelastic, to price changes while long-run supply is fairly elastic for most goods. Elasticity is an extremely useful concept for politicians as well as economists. Elasticity can be used to design more effective policies to generate tax revenues.

After you study this chapter, you should be able to:
· Explain how elasticity means sensitivity.
· List the determinants of price elasticity of demand.
· Distinguish between the elastic, inelastic, and unit elastic ranges on a straight-line demand curve.
· Contrast the cross elasticity of demand for substitutes and complements.
· Categorize goods as normal or inferior using the income elasticity of demand.
· Calculate price elasticity of supply for short-run and long-run supply curves.
· Use elasticity concepts to evaluate tax policies.

On the Net

• Coke and Pepsi are close substitutes, and the demand for each is relatively elastic. What strategies do Coca-Cola (http://www.cocacola.com/) and Pepsi (http://www.pepsi.com/) use to make the demand for their products less elastic?

• Visit a few of the major antitobacco groups: the American Lung Association (http://www.lungusa.org/noframes/learn/smoke/index.html), the Tobacco Control Resource Center (http://www.tobacco.neu.edu/), and Smoke-Free Kids, an initiative by the U.S. Department of Health and Human Services (http://www.smokefree.gov/). What are these groups doing to increase the elasticity of demand for cigarettes?

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Economic Consultants

Pharmaceuticals, Inc., has developed Aspirnew, a new type of pain reliever. Aspirnew relieves pain longer than regular aspirin, and the drug does not cause stomach upset. Pharmaceuticals has been given permission to sell the drug without a prescription.

Before Pharmaceuticals introduces Aspirnew to the market, the creators have approached Economic Consultants to consider the economic implications of offering a new drug. Prepare a report for Pharmaceuticals that addresses the following issues:

1. How elastic is the demand for over-the-counter pain relievers?
2. What are the major competitors for Aspirnew? In relation to these competitors, what pricing strategy should Pharmaceuticals implement?
3. What issues regarding cross elasticities does Pharmaceuticals need to consider?

• Tylenol
(http://www.tylenol.com/)
Tylenol provides product information and advertising.

• Pharmaceutical Research and Manufacturers of America (PhRMA)
(http://www.phrma.org/)
PhRMA represents approximately 100 U.S. companies committed to pharmaceutical research. Information includes drugs in development and industry statistics.

• U.S. Food and Drug Administration (FDA)
(http://www.fda.gov/)
The FDA is the federal government's consumer protection agency for food and drugs.

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Interactive Quiz

Test your understanding of the chapter's concepts with the interactive quiz. The quiz contains twenty multiple-choice questions, like those found on a typical exam. Questions include detailed feedback for each answer, so that you may know instantly why you have answered correctly or incorrectly. In addition, you may email yourself and/or your instructor the results of the quiz, with a listing of correct and incorrect answers. Finally, check your results versus other students around the world -- previous scores to quizzes are displayed online.

How to Take the Quiz
Start the quiz, type in your name (required), your email address (optional), and the email address of your instructor (optional). Answer the questions (as many or as few as you like, but you need to answer at least one question). Then hit the submit button and see your results. At the results page, click on the link in the "description" column to see feedback on your answers. Scroll down the page to see quiz results from students around the world.

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Author Updates

Pampers Reportedly Prevent, Treat Rash

You no doubt can't remember, but a major discomfort in your young life as a 6-month-old was diaper rash. That rash is caused partly by wetness, which causes irritation and abrasion of the baby's bottom, which leads sometimes to sores that could require medical attention.

Well, Proctor & Gamble, at last, comes to the rescue. Maybe too late for you but P&G says it has developeed the first diaper medically proved to prevent and treat rashes. If you're excited, so is P&G! The company thinks parents would be willing to pay 50 percent more than they do for regular pampers.

The pamper Rash Guard appeared on the market for the first time last week. They contain stripes treated with petroleum, found in petroleum jelly, and stearate, a skin conditioner. The diaper can still absorb waste because not all areas are treated with the conditioners.

P&G hopes the diaper will be good not only for the bottom, but for the bottom line. A jumbo package of 36 Rash Guard diapers costs about $13.25, the same as the average price of 56 basic diapers. That works out to about 37 cents for each Rash Guard diaper compared with 24 cents for the standard product.

"Our consumer research has shown us not only that diaper rash is a painful and common ailment for children, but it cause a genuine misery for parents who feel guilty over not being able to prevent their children't suffering", P&G spokesman Scott Stewart said Friday. "This is a way to help both".

Dena Smith, the mother of a 6-month-old girl and an aide at Hope Early Childhood Center in Cincinnati, said she is interested, but might try to save money by limiting use of the new diapers to nights, when changes are less frequent. "I would be willing to try anything I thought would help, but the added expense may keep some people from trying it", she said.

Source: AP (Cincinnati) in the Champaign-Urbana News-Gazette, February 27, 1999, p. B-12.

1. What does the article tell you about the price elasticity of demand for Rash Guard? Imagine Rash Guard raising its price from 24 cents to 37 cents. Within that price range, what does P&G expect? It expects "to increase the bottom line". That means that the increase in price will increase total revenue. If P&G guesses correctly, then the price elasticity of demand for Rash Guard - with that price range - is inelastic.

Updated 3/6/99

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