Elasticity - What will you do when prices change?

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Hey, Naz, If electricity becomes more expensive, what would you do?
I mean, I'd probably keep using it. Electricity. It powers
my lights, the fridge. I use it to charge my phone,
my computer, so I kind of I rely on it
day to day.
Really, yeah, you couldn't exactly give up on electricity, even
if it's really expensive, but think about how you use
might change.
I'd probably try to remember to turn the lights off
when I leave the room, which I should be doing anyway.
But I mean, I don't really have another option.
Okay, So now let's think about something else. What would
you do with the price of Hinz Ketchup doubled? Would
you keep buying it?
No? No, I mean there's all these other brands of
ketchup and they kind of taste the same.
So your demand for electricity barely responds to the brace,
while your demand for Hind's ketchup responds a lot. Economists
use the term elasticity to refer to how responsive buyers
and sellers are the price changes, and elasticity is our
topic for today's episode of Think Like an Economist with
Me Betsy Stevenson and.
With me just Amorphus. Remember this is the podcast where
we'll teach you the superpowered tools of economics to transform
your life. Nesta Antebercolifa joins us as we dive in
so elasticity.
This makes me think about elastic bands and stretching things out.
Yeah, that's It's a pretty useful way to think about it.
Economists use the word elasticity to describe how flexible you
are as a buyer or seller. Do you change your
behavior a lot or a little when the price changes?
So thinking about things being stretchy or flexible or responsive
is exactly what elasticity is all about.
Let me be more specific. The measure of how much
people respond to price changes is called price elasticity. When
we're looking at how buyers respond to price changes, we
talk about the price elasticity of demand and the price
elasticity of supply. Measures how much sellers change the quantity
they produce if the price changes.
And in both cases, if you're more elastic, you're stretchier,
more flexible, more responsive. You respond more to changes in prices,
So small changes in price cause relatively larger changes in
the quantities you buy or sell. But if you're inflexible
so that your decisions don't change much as the price changes,
we say that you're in a lifetick or you have
inelastic demand or supply.
Let's start with demand. So the lure of demand says
that we tend to buy more of something when the
price is lower, and conversely, we tend to buy less
of something when the price is higher.
That's right, And the idea of elasticity is to move
to the next question of how much more or how
much less. It's about quantifying that change. If heinz ketchup
is ten percent more expensive, how much less of it
will people buy? That how much question is a really
big deal for the folks who.
Run hines And if you know the price elisticity of
demand for hines ketchup, you can give a pretty good estimate.
Let me be precise, The price elasticity of demand is
the ratio of the change in quantity to the change
in price, where all of these changes are measured in percentages.
So if the price elasticity of demand for Heinz Ketchup
is three, then the change in the quantity of Heinz
Ketchup people will buy will be three times larger than
the change in price. So if Heinz raises Ketchup prices
by ten percent, people would buy thirty percent less Heinz Ketchup.
That's pretty responsive. In fact, this ratio is more than
one when the price elasticity of demand for a good
is elastic. Remember when demand for good is elastic, buyers
will respond a lot to a small change in price.
Now, Nas, if the price of electricity rose by ten percent,
how much less electricity would you use?
Yeah? I mean I use electricity for almost everything. So
if the price went up a small amount like this,
I mean, I don't think it's going to affect how
much I use it. I might remember to turn off
the lights a little bit more frequently.
And that's not going to change your electric bill. By match.
It's maybe a one or two percent decline and how
much electricity you use, So because your change in electricity
use would be small compared to the change in the price.
Your demand is relatively unresponsive or inelastic.
So my demand for some goods is elastic, and my
demand for other goods is inelastic. And given this, how
can I tell if something's gonna be more or less
elastic when it comes to my demand?
Now, as you said, you'd probably stop buying Heinz Ketchup
if the price doubled, and you talked about how there
are other things you could buy instead. You're thinking like
an economist. That's the opportunity cost principle at work. You asked,
or what exactly?
Because if I don't buy Heinz Ketchup, I can buy
another brand, and there's a lot of them out there.
That's the key to elasticity. Your next best alternative to
Heinz Ketchup is a pretty good substitute some other brand
of Ketchup. That substitutability is what makes your demand for
Heinz Ketchup so elastic. The better the substitutes for a good,
the more willing you'll be to respond to a price
rise by buying something else.
So the more competing products there are, the more elastic
the demand is for that good. Think about it. People
have alternatives they can buy instead, and the more indifferent
they are between their current choice and their next best alternative,
the more likely they'll be to switch if the price changes.
But Naz, how about if all Ketchup brands raise their prices, Say,
tomatoes are really expensive this year, so the price of
Ketchup goes up.
I'd probably end up using more mayonnaise, but I'm still
gonna want to have ketch Up now.
And then yeah, now, think about what you do if
the price of all condiments went up, you know, like
catch up mayonnaise everything.
Oh so I could just put more salts on everything maybe,
but that sounds really boring. So I'm still gonna need
my condiments.
Right, So, your demand for Heinz Ketchup is really elastic,
your demand for Ketchup overall is a bit less elastic,
and your demand for condiments in general is well pretty inelastic.
Swapping one brand of Ketchup for another is very different
from swapping the use of condiments as a whole to
something else entirely.
But you know, I do have a friend who swears
that Heinz Ketchup is the best thing ever, So I
don't think she'd ever give it up.
Yeah, that's what every brand would love to hear. Advertising
is designed to make you think that there are really
no good substitutes for their product. If you fall for it,
then you'll be more likely to keep buying Heine's ketchup
as they raise the price.
Now, let's look at a harder example. What would you
do if you had diabetes and the price for insulin
to treat it rose.
I'd go on buying it because I need it.
Necessities like this tend to have very inelastic demand. In fact,
you may remember the famous case of the farmer bro
Martin schir Crully, the sketchy guy who was the CEO
of Turing Pharmaceuticals. He checked up the cost of the
life saving drug daraprim by five thousand percent.
Yeah you know, I remember this because the price went
from thirteen dollars fifty a tablet to seven hundred and
fifty dollars overnight, which was just outrageous.
Yeah, you really can't forget it. Story. People were pretty
mad because this drug was the only treatment for rare illness.
He figured he could charge whatever he wanted because back
then there were no useful substitutes for dire prim so
people would still have to buy it. He might have
gotten his calculations right, but people really hated him for it.
Okay, I think I'm getting it. So, if you don't
have a good alternative for something, your demand is fairly
and elastic.
That's right. On the other hand, when there are alternatives
and you're able to shop around, then your demand will
be more elastic.
You know, before he could buy stuff online, demand used
to be much less elastic because you had to visit
a bunch of stores to try to get a better deal. Nowadays,
people can compare the price across dozens of sellers with
just a few clicks. That's made the demand for lots
of things much more elastic. So economists think about how
hard it is to search for alternatives as a factor
that affects the price elasticity of demand.
Finally, demand for most goods gets more elastic over longer
periods of time.
And is this because we've got longer to figure out
how to adjust to these higher prices.
Yes. Let's take your demand for electricity. If the price
of electricity rose, there's not much you can do today
or tomorrow to use less of it. But over time,
as your appliances breakdown, you might replace them with energy
efficient versions. And if you expect the price of electricity
to stay high for a long time, eventually you might
even install solar panels.
The longer you have to make adjustments, the more adjustments
you'll make, so your demand becomes more elastic over time.
And remember the key is where there are good substitutes
for you to buy instead.
Betsy justin, we've been digging into elasticity. Why is any
of this important?
Knowing about elasticity helps sellers set their prices and predict
how much money I'll make. Specifically, it helps them determine
their revenue the total quantity they'll sell times the price.
So we've been talking about Heines catch up. Let's say
the price goes up. What happens to revenue?
So remember we said that if demand is elastic, a
change in the price will lead to a big change
in quantity. If Hines jacks up the price of their
catch up by ten percent, people will buy thirty percent
less of it. As a result, Heines's revenues will go down.
However, if demand is in elastic, then people will keep
buying about the same amount even though the price is
much higher. That's what Martin Shakrelly was banking on. He
hoped that he could charge a lot more for dhraprim
and still keep most of his customers and so make
more money.
We've really delved into demand earlier. You said that elasticity
also matters when it comes to supply.
It does, and the idea is pretty similar. You know
how changes in the price of coffee leads buyers to
respond by consuming more or less coffee. Well, sellers also
respond if the price goes up. They'll ramp up production,
trying to sell more the praise. Elasticity of supply measures
how much they change their supply, and just like demand,
it's a measure of their flexibility. The more elastic supply is,
the more flexible sellers are to respond to higher prices
by increasing their supply.
The price elasticity of supply is the ratio of the
change in the quantity supplied to the change in the price.
This ratio is a measure of how responsive sellers are
to changes in prices. And again we measure all of
these changes in percentages.
Okay, let's say the price of coffee rises by ten percent,
how are coffee shops going to respond well.
Selling coffee just became more profitable. I'd expect a lot
of things to change. Some coffee shops might hire extra
staff or stay open later. Others might install extra espresso machines.
Entrepreneurs might open new coffee shops. The coffee business has
raise a thin margins, so if the price rose by
ten percent, I think you'll see a pretty dramatic response.
The price elasticity of supply summarizes all of these responses
by coffee sellers. So if the price of coffee rises
by ten percent and coffee shops increase the quantity they
supply by forty percent, then the price elasticity of supply
is four.
That's really responsive. In fact, whenever the percentage change in
quantity supplies are willing to sell is larger than the
percentage changing price, we'll say that supply is elastic.
Not all industries are this responsive. For instance, if the
price of airline tickets rises, it's really hard for airlines
to increase supply because each plane has a fixed number
of seats. They only have so many planes, and it's
really hard to train new pilots.
So we're saying that supplies an elastic because a change
in the price doesn't really impact the number of flights
that airlines can provide.
That's right. The supply is inflexible, so we say it's inelastic,
at least initially.
So what determines whether the supply of a good is
going to be elastic like coffee or inelastic like flights.
It all comes back to flexibility. Do sellers have the
flexibility to change how much they produce and sell if
the price changes? And there are a number of factors
that can help you figure out how flexible suppliers are.
First, there's the availability of your inputs. If you run
a coffee shop, you can easily buy more beans and
hire more baristas if you want to make more cups
of coffee. But if the price of plane tickets goes up,
it's hard for airlines to suddenly hire more pilots who
are highly trained and relatively scarce. It's also hard for
them to buy more planes.
Another factors inventories. Let's go back to coffee and focus
instead on just coffee beans. These can be stored for
years before roasting, so if the price is really low
one year, coffee bean wholesalers can just stash them away
and then sell this inventory when prices go up, so
the more inventory you have, the more elastic supply can be.
Also, having more capacity makes supply more elastic. Let's get
back to planes. The key capacity constraint for many airlines
is that they need to have a gate at the
airport where they can board their passengers. But each airport
only has a fixed number of gates, so it's impossible
to expand the number of flights to beyond a certain point.
By contrast, to coffee shop might have a lot of
unused capacity, such as coffee machines not being used as
much as they could be, so it'll be pretty easy
to ramp up production.
Yeah, and you know you keep bringing up the market
for coffee as having pretty elastic supply.
Yep, And it's not just about how existing coffee shops respond.
A high price might also induce people to open new
coffee shops. It's not that hard to rent a space
and equipment and start up a coffee shop, so easy
entry makes the supply of coffee more elastic. By contrast,
starting a new airline is super difficult. You'll need billions
of dollars and all sorts of government approvals.
Finally, our good friend time catches up with us all. Eventually,
supplies are also more elastic over time. We said that
it's hard to suddenly increase the supply of flights, but
over time, if airfares remain high, airlines might respond by
purchasing new planes, jocking for more gates, and even expanding
into new airports.
It seems that with time everything becomes more elastic.
Yes, time really does stretch things.
We've just stretched out the concepts of elasticity. How can
we summarize it?
Ah elasticity helps us understand how much the quantity demanded
and supplied will change when the price changes.
The price elasticity demand measures how much bias respond to
price changes. Will an increase in price make them buy
a lot less or just a little less? The antswer
will depend on whether bias have useful substitutes.
The price elasticity of supply is about asking a similar
question of sellers. Will a price hike lead them to
expand their production a lot or a little? This depends
on the flexibility that suppliers.
And with all of this in mind, what should we
start thinking about?
Next time you're at the store, you'll be looking at
dozens of prices as you shot with some goods, if
it's on sale, you'll stock up with others you'll respond less.
Use this insight to figure out which goods you have
an elastic or inelastic demand for, and once you've.
Done that, put yourself in the shoes of a manager
at a company that sells each of these products. Do
your insights about the elasticity of demand shape the sorts
of marketing and pricing strategies you might pursue if you
were that manager.
BET's justin. I'm going to spend the next couple of
days going around and seeing how flexible I am about
my purchasers.
Is that an elasticity analogy stretched to breaking point?
Looking forward to talking with you about the price elasticity
of your demand for yoga as no mistake. To get
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