Prof. Rowe and Liam illustrate the elasticity of demand for a product regarding price changes as a possible explanation for tariff consequences (simulation)

Script: 

Characters:

• Professor Rowe: International Economics professor, thoughtful and clear communicator.

• Liam: First-year economics student, curious and eager to understand real-world applications of trade theory.

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Scene 5: Office Hours, Discussion on Elasticity of Demand

Liam returns to Professor Rowe’s office, intrigued by a new economic term from class.

Liam:
Hey Professor Rowe, we talked about elasticity of demand today in class, but I’m still trying to fully grasp it. Could you explain it a bit more simply?

Prof. Rowe:
Of course, Liam. Elasticity in economics is basically about how sensitive people are to changes in price. Precisely, price elasticity of demand measures how much the quantity demanded of a product changes in response to a price change.

Liam:
Could you give me an example?

Prof. Rowe:
Sure, let’s imagine a scenario. Suppose a car costs $30,000, and the current demand is 100 units. If the price goes up by 25%, we determine the new price.

Liam:
Okay, 25% of $30,000 would be…$7,500, right?

Prof. Rowe:
Exactly. So the new price is $37,500. Now, let's say this car's price elasticity of demand (PED) is 2. Remember, PED is the percentage change in quantity demanded divided by the percentage change in price.

Liam:
Right. So, since the price went up 25%, what happens next?

Prof. Rowe:
We multiply the PED by the percentage change in price. With PED equal to 2, we have:

Plugging in our numbers:

So, the percentage change in quantity demanded equals 2 multiplied by 25%, which is 50%.

Liam:
And that means quantity demanded will drop, right? Because people buy fewer cars at a higher price?

Prof. Rowe:
Exactly. When demand is elastic—meaning PED is greater than 1—a price increase leads to a significant drop in quantity demanded. In this case, the 50% decrease means the quantity demanded drops from 100 to 50 units.

Liam:
Got it! So, after the price hike, only 50 cars would likely be sold instead of 100.

Prof. Rowe:
Precisely. Elasticity helps businesses and economists predict how customers react to price changes and helps guide strategic decisions.

Liam:
How do economists calculate that elasticity, though? How did they come up with 2 for this car example?

Prof. Rowe:
That's a great question! Economists typically use a few different methods. The most common is analyzing historical sales data, looking at how past price changes affected demand. They collect this data, perform statistical analyses, like regression analysis, and estimate how sensitive demand is to price shifts.

Liam:
Is that the only way?

Prof. Rowe:
No, there are other approaches. Economists might also conduct surveys or experiments, asking consumers how they'd react to hypothetical price changes or observing actual buying behavior at different price points in controlled settings. Another method is econometric modeling, which uses statistical models incorporating multiple economic factors like income, prices of related goods, and advertising expenditures.

Liam:
Sounds complex!

Prof. Rowe:
It can be! However, each method has its strengths and challenges. For instance, historical analysis relies heavily on data quality and other influencing factors. Surveys can suffer from hypothetical bias, and experiments can be costly. Econometric models require careful selection of variables and good-quality data.

Liam:
And elasticity isn't always the same, right?

Prof. Rowe:
Exactly. Elasticity can change depending on the price level, the availability of substitutes, the time horizon, and even specific market segments. Economists usually estimate elasticity for particular products, markets, and time periods to get the most accurate insights.

Liam:
Thanks again, Professor Rowe! This really clarified things for me.

Prof. Rowe:

You're always welcome, Liam. Keep up the good work! 

Before you go, let me add something to clarify the relationship. When tariffs raise the price of imported goods, understanding elasticity helps predict how much demand for those products may fall. If demand is highly elastic (PED > 1), consumers will significantly reduce their purchases in response to higher prices. Conversely, if demand is inelastic (PED < 1), the quantity demanded might not decrease dramatically.