Holt 7525-9 S15_IT

Example 5A: Gertie’s Gas and Go is one of many retail gas outlets in town. Gertie’s increases
the price of its gasoline by 10¢ per gallon. No other gas outlets in town raise their prices. Gertie’s
sells much less gasoline than before the price increase. Since there are many substitutes for
Gertie’s gasoline, the demand for Gertie’s gasoline is very elastic.
Example 5B: Gertie’s Gas and Go increases the price of its gasoline by 10¢ per gallon. All other
gas outlets in town also raise their prices by 10¢. Gertie’s and the other gas outlets sell nearly as
much gasoline as before the price increase. Since there is no close substitute for gasoline, the
demand for gasoline is very inelastic.
2. The percentage of a person’s budget spent on the good. The greater the percentage of a
person’s budget spent on a good, the more elastic the demand for the good. The smaller the
percentage of a person’s budget spent on a good, the less elastic the demand for the good.
Example 6: When the price of eggs increases by 20%, Pam does not decrease her consumption
of eggs. When Pam’s rent increases by 20%, she begins looking for a new apartment.
3. Nature of the good; luxury versus necessity. For luxury goods, demand tends to be elastic.
For necessities, demand tends to be inelastic.
Example 7: When the price of Ahmad’s heart medicine increases by 30%, he continues to
purchase the same quantity of heart medicine. When the prices at Ahmad’s favorite restaurant
increase by 30%, he cuts back dramatically on his trips to the restaurant.
4. Time consumers have to respond. The more time consumers have to respond to a price
change for a good, the more elastic the demand for the good. The less time consumers have
to respond to a price change for a good, the less elastic the demand for the good.
Example 8: If the price of gasoline increases by 75%, the quantity demanded in the next week
would decrease by a small amount. If the price of gasoline stays high for a year, the quantity
demanded will decrease more, as consumers trade for more fuel-efficient cars, form car pool
arrangements, switch to public transportation, etc.
Income Elasticity of Demand (E Y )
One of the determinants of demand (factors that shift the demand curve) discussed in Chapter 3
is consumer income. A change in consumer income will cause a change in demand in the same
direction (for normal goods) or in the opposite direction (for inferior goods). Income elasticity of
demand measures the responsiveness of demand to a change in income. The formula for income
elasticity of demand is:
E Y = Percentage Change in Quantity Demanded ÷ Percentage Change in Income
In computing income elasticity of demand, the percentage changes are calculated in the same
manner used in computing price elasticity of demand. However, we will no longer be treating the
changes as absolute values. For income elasticity of demand and for cross elasticity of demand
(discussed on the next page), whether the answer is positive or negative is significant. Income
elasticity is positive for normal goods and negative for inferior goods. The formula for income
elasticity of demand is:
Change in Quantity Demanded Q 2 – Q 1
Average Quantity Demanded (Q 2 + Q 1 )/2
E Y = —————————————— = —————
Change in Income Y 2 – Y 1
Average Income (Y 2 + Y 1 )/2
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17 - 5 Elasticity