GED Social Studies Practice Test: Elasticity of Demand

What is elasticity of demand? It’s the change in demand — sometimes big, sometimes small — for a product or service when the price changes. In other words, how will a higher price or a lower price affect the demand?

Here are two very plausible scenarios: A company achieves greater efficiency and is able to drop the price of a good a little bit. But demand for the good increases a lot. On the flip side, a small price increase may lead to a significant drop in demand.

Not every good (we’ll leave out services for the time being) has elastic demand. But those that do tend to share three things in common:

  1. the product is not a necessity (it’s a “nice to have” and not a “need to have”);
  2. there are substitutes for that good; or
  3. the good represents a sizeable chunk of the consumer’s income.

Let’s look again at the demand curve for pizza mentioned above. As you can see, even a small change in price causes a big change in demand. Pizza is not a necessity (well, for most people, anyway), and there are substitutes (hero sandwiches; tacos; falafel, etc.). And, when times are tight and you have less money, even a couple of dollars that you’d spend on pizza might be better spent on something else.

Inelastic Demand occurs when a change in price — whether small or large — has little or no change on the quantity of goods demanded.  Goods with inelastic demand tend to share three things in common:

  1. the product is a necessity (a “need to have” and not a “nice to have”);
  2. there are few (if any) substitutes; or
  3. the good does not represent a sizeable chunk of the consumer’s income.

Let’s name some goods that have elasticity of demand and some that have inelasticity of demand:

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These are just a few examples, but you can easily see the difference. There are simply some things you cannot do without, and there are no substitutes. As long as there are children and cars, households need milk and gasoline. There are no substitutes (or, the substitutes are impractical — such as biofuels — or unpalatable — such as powdered milk). If the price of milk jumps from $3 a gallon to $5 a gallon, consumption will largely remain unchanged, because children need to drink milk. Ditto the situation with gasoline. Your car won’t run on your goodwill alone!

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