Price elasticity of demand
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Intros
Lessons
- Price Elasticity of Demand Overview:
- Definition for Elasticity
- Analyze supply and demand with good precision
- How buyers and sellers respond to change
- Price Elasticity of Demand
- Why is it important
- Formulas for Price Elasticity of Demand
- Two ways to calculate Elasticity of Demand
- Point Elasticity of Demand
- Arc Elasticity of Demand
- An Example of using both
- Notes about Price Elasticity of Demand
- Why use average price and quantity?
- Percentages and Proportions
- Units-Free Measure
- Types of Demand Curves
- Inelastic demand and elastic demand
- What each value of elasticity means
- Perfectly inelastic, perfectly elastic, unit elastic
- Total Revenue and Price Elasticity of Demand
- How to calculate total revenue
- How revenue changes in an inelastic demand
- How revenue changes in an elastic demand
- How revenue changes in a unit elastic demand
Examples
Lessons
- Understanding Price Elasticity of Demand
Suppose the price of oranges increases from $1 to $3 a box, and the quantity demanded decreases from 500 to 300 boxes a day. Calculate the point elasticity of demand and the arc elasticity of demand. - If the quantity of car services demanded increases by 30% when the price of car services decrease by 20%, is the demand for car service elastic, inelastic, or unit elastic?
- The following graph shows the demand for books.
- Suppose the company decided to decrease the price of chocolate from $10 to $6. They expect that the price cut will boost the chocolate sales by 40%.
- Suppose the company decided to decrease the quantity of phones from to 100 to 70. They expect that the quantity cut will boost the price sales by 22.2%.
Topic Notes
Introduction to Price Elasticity of Demand
Price elasticity of demand is a crucial concept in economics that measures how sensitive consumer demand is to changes in price. Our introduction video provides a comprehensive overview of this concept, making it easier for students and professionals to grasp its significance. This article delves into the intricacies of price elasticity of demand, explaining how to calculate it and why it's so important in economic analysis. Understanding price elasticity allows businesses and policymakers to make informed decisions about pricing strategies and market interventions. We'll explore how different factors influence elasticity and how it varies across different products and industries. By the end of this article, you'll have a solid foundation in price elasticity of demand, enabling you to apply this knowledge to real-world economic scenarios and make more informed business decisions.
Understanding Price Elasticity of Demand
Price elasticity of demand is a crucial economic concept that measures how sensitive the quantity demanded of a good or service is to changes in its price. This concept plays a vital role in understanding consumer behavior and market dynamics. Essentially, it quantifies the relationship between price fluctuations and the resulting changes in demand.
When we say that quantity demanded responds strongly to changes in price, we are referring to a situation where the demand is elastic. In such cases, even a small change in price can lead to a significant shift in the quantity demanded. For instance, if a 5% increase in price results in a 10% decrease in quantity demanded, we would consider this demand to be elastic.
On the other hand, when demand is inelastic, changes in price have a relatively small impact on the quantity demanded. For example, if a 10% increase in price only leads to a 2% decrease in quantity demanded, we would describe this as inelastic demand.
The importance of elasticity in analyzing supply and demand cannot be overstated. It provides valuable insights for businesses, policymakers, and economists in several ways:
1. Pricing strategies: Companies use elasticity information to set optimal prices. If demand is elastic, raising prices might lead to a significant drop in sales, while if it's inelastic, price increases may not significantly affect demand.
2. Revenue forecasting: Understanding elasticity helps predict how changes in price will affect total revenue. For elastic goods, lowering prices might increase revenue by boosting sales volume, while for inelastic goods, raising prices could increase revenue despite lower sales volume.
3. Tax policy: Governments consider elasticity when implementing taxes. Highly elastic goods are less suitable for taxation as consumers can easily reduce consumption or find substitutes.
4. Market analysis: Elasticity helps in understanding market structures and competition. Markets with highly elastic demand tend to be more competitive, as consumers can easily switch between products.
To illustrate the concept, let's consider some examples:
1. Luxury goods: High-end watches or designer clothing often have elastic demand. A small increase in price might cause a significant decrease in demand as consumers view these as non-essential items.
2. Necessities: Basic food items like bread or milk typically have inelastic demand. Even if prices increase, people still need to buy these items, so the quantity demanded doesn't change dramatically.
3. Gasoline: In the short term, gasoline demand is often inelastic because people need it for daily commutes. However, in the long term, it becomes more elastic as people might switch to more fuel-efficient cars or alternative transportation methods if prices remain high.
4. Entertainment: Movie tickets or streaming services often have elastic demand. If prices increase significantly, people might choose alternative forms of entertainment or reduce their consumption.
The formula for calculating price elasticity of demand is: (Percentage change in quantity demanded) / (Percentage change in price). If the result is greater than 1, demand is considered elastic. If it's less than 1, demand is inelastic. A result of exactly 1 is known as unit elastic.
It's important to note that elasticity can vary over different price ranges for the same product. A good might have elastic demand at higher price points but inelastic demand at lower prices. Additionally, elasticity can change over time as consumer preferences, income levels, and available alternatives evolve.
Factors influencing price elasticity of demand include the availability of substitutes, the necessity of the good, the proportion of income spent on the good, and the time frame considered. Goods with many substitutes tend to have more elastic demand, while necessities and goods that constitute a small portion of a consumer's budget often have inelastic demand.
In conclusion, price elasticity of demand is a fundamental concept in economics that provides valuable insights into consumer behavior and market dynamics. By understanding how quantity demanded responds to price changes, businesses can make informed decisions about pricing strategies, while policymakers can better predict the impact of economic policies. Whether dealing with elastic or inelastic demand, this concept remains an essential tool for analyzing and navigating the complexities of supply and demand in various markets.
Calculating Price Elasticity of Demand
Understanding how to calculate price elasticity of demand is crucial for businesses and economists to analyze consumer behavior and market dynamics. This step-by-step guide will walk you through the process of calculating both point elasticity and arc elasticity, with a focus on the arc price elasticity of demand formula.
Step 1: Understand the Concept
Price elasticity of demand measures the responsiveness of quantity demanded to changes in price. It's expressed as a ratio of the percentage change in quantity demanded to the percentage change in price.
Step 2: Point Elasticity Formula
The point elasticity formula is used when dealing with small changes in price and quantity. The formula is:
Point Elasticity = (% Change in Quantity Demanded) / (% Change in Price)
Or more specifically:
Point Elasticity = (ΔQ/Q) / (ΔP/P)
Where ΔQ is the change in quantity, Q is the initial quantity, ΔP is the change in price, and P is the initial price.
Step 3: Calculate Point Elasticity
Example: If the price of apples increases from $1 to $1.10, and the quantity demanded decreases from 100 to 90 apples:
ΔQ/Q = (90 - 100) / 100 = -0.1 or -10%
ΔP/P = ($1.10 - $1) / $1 = 0.1 or 10%
Point Elasticity = -0.1 / 0.1 = -1
Step 4: Interpret Point Elasticity
A result of -1 indicates unitary elasticity, meaning the percentage change in quantity demanded is equal to the percentage change in price. If the absolute value is greater than 1, demand is elastic; if less than 1, demand is inelastic.
Step 5: Understand Arc Elasticity
For larger price changes, the arc price elasticity of demand formula is more accurate. It uses average values of price and quantity to account for significant changes.
Step 6: Arc Price Elasticity of Demand Formula
The formula is:
Arc Elasticity = [(Q2 - Q1) / ((Q2 + Q1) / 2)] / [(P2 - P1) / ((P2 + P1) / 2)]
Where Q1 and P1 are initial quantity and price, and Q2 and P2 are final quantity and price.
Step 7: Calculate Arc Elasticity
Using the same example:
Q1 = 100, Q2 = 90, P1 = $1, P2 = $1.10
Arc Elasticity = [(90 - 100) / ((90 + 100) / 2)] / [($1.10 - $1) / (($1.10 + $1) / 2)]
= [-10 / 95] / [0.10 / 1.05] -1.05
Step 8: Interpret Arc Elasticity
The result of -1.05 indicates that demand is slightly elastic, as the absolute value is just over 1. This means the percentage change in quantity demanded is slightly larger than the percentage change in price.
Why Arc Elasticity is More Accurate
The arc price elasticity of demand formula is more accurate for larger price changes because it uses average values. This approach smooths out the calculation, providing
Types of Price Elasticity of Demand
Price elasticity of demand is a crucial economic concept that measures how sensitive consumer demand is to changes in price. Understanding the different types of price elasticity can help businesses and policymakers make informed decisions about pricing strategies and market interventions. There are three main types of price elasticity of demand: elastic demand, inelastic demand, and unit elastic demand.
Elastic demand occurs when the percentage change in quantity demanded is greater than the percentage change in price. This means that consumers are highly responsive to price changes. Products with elastic demand typically have many substitutes or are considered non-essential. For example, luxury goods, entertainment services, and brand-name clothing often exhibit elastic demand. If the price of a particular brand of smartphone increases by 10%, the quantity demanded might decrease by 15% or more as consumers switch to alternative brands or delay their purchases.
Inelastic demand, on the other hand, is characterized by a smaller change in quantity demanded relative to the change in price. In this case, consumers are less sensitive to price fluctuations. Essential goods and services, such as basic food items, utilities, and prescription medications, tend to have inelastic demand. For instance, if the price of gasoline increases by 10%, the quantity demanded might only decrease by 2-3%, as many people still need to drive to work or school regardless of the price.
Unit elastic demand represents the middle ground between elastic and inelastic demand. In this scenario, the percentage change in quantity demanded is exactly equal to the percentage change in price. This results in a proportional relationship between price and quantity. While unit elastic demand is more of a theoretical concept, some products may approach this state at certain price points.
At the extreme ends of the elasticity spectrum, we find perfectly elastic and perfectly inelastic demand curves. Perfectly elastic demand occurs when even a tiny increase in price leads to a complete loss of demand, while any decrease in price results in an infinite increase in demand. This situation is rare in real markets but can be approximated in highly competitive markets with nearly identical products. For example, in a commodity market where all sellers offer the same product at the same price, any seller who raises their price even slightly may lose all their customers to competitors.
Conversely, perfectly inelastic demand represents a situation where changes in price have absolutely no effect on the quantity demanded. This is also a theoretical extreme that is rarely observed in practice. The closest real-world examples might include life-saving medications with no alternatives or addictive substances for individuals with severe dependencies. In these cases, consumers may continue to purchase the same quantity regardless of price increases.
Understanding these different types of price elasticity is essential for businesses when setting prices and developing marketing strategies. For products with elastic demand, companies may focus on competitive pricing and highlighting unique features to differentiate themselves from substitutes. In contrast, for goods with inelastic demand, businesses may have more flexibility in pricing but should be cautious about potential public backlash or regulatory scrutiny if prices are perceived as exploitative.
Policymakers also benefit from knowledge of price elasticity when designing tax policies or implementing market regulations. For instance, taxes on goods with inelastic demand, such as cigarettes, can be effective in raising revenue without significantly reducing consumption. However, similar taxes on elastic goods may lead to substantial changes in consumer behavior and potentially unintended consequences.
It's important to note that elasticity can vary over time and across different market segments. Factors such as the availability of substitutes, consumer income levels, and the time frame considered can all influence the elasticity of demand for a particular product or service. Additionally, elasticity may change as prices reach certain thresholds or as consumer preferences evolve.
In conclusion, the concept of price elasticity of demand, encompassing elastic, inelastic, and unit elastic demand, as well as the theoretical extremes of perfectly elastic and perfectly inelastic demand, provides a valuable framework for analyzing consumer behavior and market dynamics. By understanding these different types of elasticity, businesses can optimize their pricing strategies, and policymakers can make more informed decisions about economic interventions, ultimately leading to more efficient markets and better outcomes for consumers and society as a whole.
Factors Affecting Price Elasticity of Demand
Price elasticity of demand is a crucial economic concept that measures how sensitive consumer demand is to changes in price. Several key factors influence this elasticity, determining whether demand for a product is elastic or inelastic. Understanding these factors is essential for businesses and policymakers in making informed decisions about pricing strategies and market interventions.
One of the primary factors affecting price elasticity is the availability of substitutes. When consumers have easy access to alternative products that can fulfill similar needs, demand tends to be more elastic. For instance, if the price of beef increases, consumers might switch to chicken or pork, making the demand for beef more elastic. Conversely, products with few or no substitutes, like insulin for diabetics, tend to have inelastic demand as consumers have limited alternatives.
The nature of the good, whether it's a necessity or a luxury, significantly impacts price elasticity. Necessity goods, such as basic food items, medications, and utilities, generally have inelastic demand. People need these items regardless of price changes, so demand remains relatively stable. On the other hand, luxury goods, like designer clothing or high-end electronics, typically have elastic demand. Consumers can easily forgo these items if prices increase, making demand more sensitive to price changes.
The proportion of income spent on a good also influences its price elasticity. Products that consume a larger portion of a consumer's income tend to have more elastic demand. For example, a car purchase represents a significant expense for most households, making car demand relatively elastic. In contrast, small everyday items like pens or toothpaste account for a tiny fraction of income, resulting in more inelastic demand.
Time is another critical factor in price elasticity. In the short term, demand for many goods is relatively inelastic because consumers may not immediately adjust their behavior or find alternatives. However, over longer periods, demand often becomes more elastic as people have time to explore substitutes or change their consumption patterns. For instance, if gasoline prices spike, demand might be inelastic in the short term as people still need to commute. But over time, consumers might switch to more fuel-efficient vehicles or alternative transportation methods, making demand more elastic.
The breadth of definition of a good can also affect its elasticity. Broadly defined categories, like food in general, tend to have more inelastic demand compared to narrowly defined products. While demand for a specific brand of cereal might be elastic, the overall demand for breakfast foods is likely to be more inelastic.
Additionally, the level of brand loyalty plays a role in price elasticity. Strong brand loyalty can make demand more inelastic, as consumers are willing to pay higher prices for their preferred brands. This is often seen in markets like smartphones or soft drinks, where devoted customers may stick with their favorite brand despite price increases.
Market structure and competition levels also influence elasticity. In highly competitive markets with many suppliers, demand tends to be more elastic as consumers can easily switch between alternatives. Monopolistic markets, however, often face more inelastic demand due to limited options for consumers.
Lastly, the perceived quality and uniqueness of a product can impact its price elasticity. Products viewed as high-quality or unique often have more inelastic demand, as consumers are willing to pay premium prices for these attributes. This is commonly observed in luxury goods markets or for specialized professional services.
Understanding these factors is crucial for businesses in setting optimal prices and for policymakers in predicting the impact of economic policies. By considering the interplay of substitutes, necessity versus luxury status, income proportion, time horizons, and other influencing factors, stakeholders can better anticipate how changes in price will affect consumer behavior and market dynamics.
Price Elasticity of Demand and Total Revenue
Price elasticity of demand plays a crucial role in determining a firm's total revenue and guiding pricing decisions. This economic concept measures how sensitive consumer demand is to changes in price. Understanding the relationship between price elasticity and total revenue is essential for businesses aiming to maximize their profits and make informed pricing strategies.
The price elasticity of demand directly impacts a firm's total revenue, which is calculated by multiplying the price of a good or service by the quantity sold. When demand is elastic, meaning consumers are highly responsive to price changes, a decrease in price will lead to a proportionally larger increase in quantity demanded. This results in an increase in total revenue. Conversely, when demand is inelastic, a price decrease will lead to a proportionally smaller increase in quantity demanded, causing total revenue to fall.
Firms can leverage elasticity information to make strategic pricing decisions. For products with elastic demand, lowering prices can boost sales volume significantly, potentially increasing overall revenue. For instance, in the competitive smartphone market, a company might reduce prices to capture a larger market share and increase total revenue. On the other hand, for goods with inelastic demand, firms may consider raising prices to increase revenue, as the quantity demanded will not decrease proportionally.
Let's examine how changes in price affect revenue for elastic and inelastic goods. For elastic goods, such as luxury items or non-essential products, a price reduction can lead to a substantial increase in sales. For example, if a clothing retailer reduces the price of a designer handbag by 10%, they might see a 15% increase in sales, resulting in higher total revenue. In contrast, for inelastic goods like basic necessities or addictive products, a price increase may not significantly reduce demand. A pharmaceutical company raising the price of a life-saving medication by 5% might only see a 1% decrease in quantity demanded, thereby increasing total revenue.
It's important to note that elasticity can vary along a demand curve. A good may be elastic at higher price points and inelastic at lower ones. Firms must consider this when making pricing decisions. They can conduct market research and analyze historical sales data to estimate the elasticity of their products at different price points. This information allows them to identify the optimal price that maximizes total revenue.
Moreover, firms can use elasticity information to implement dynamic pricing strategies. For instance, airlines and hotels often adjust their prices based on demand fluctuations, charging higher prices during peak seasons when demand is less elastic and lower prices during off-peak periods to stimulate demand. E-commerce platforms like Amazon use sophisticated algorithms to adjust prices in real-time based on elasticity data, competitor pricing, and other factors.
Understanding cross-price elasticity is also valuable for firms making pricing decisions. This measure indicates how the demand for one product changes in response to price changes in related products. For complementary goods, like printers and ink cartridges, a decrease in printer prices might lead to increased demand for ink, affecting the pricing strategy for both products. For substitute goods, such as different brands of cereal, a price increase for one brand might drive consumers to switch to a competitor, influencing pricing decisions across the market.
In conclusion, the relationship between price elasticity of demand and total revenue is fundamental to effective pricing strategies. By analyzing elasticity, firms can make informed decisions to optimize their pricing, maximize revenue, and gain a competitive edge in the market. Whether dealing with elastic or inelastic goods, understanding how price changes affect consumer behavior and total revenue is essential for business success in today's dynamic economic landscape.
Conclusion
Price elasticity of demand is a crucial concept in economic analysis, measuring how sensitive consumer demand is to price changes. The introduction video provides an essential foundation for understanding this concept, illustrating how elasticity varies across different products and markets. Key points to remember include the formula for calculating elasticity, factors affecting elasticity such as availability of substitutes and necessity of the good, and the distinction between elastic and inelastic demand. Understanding price elasticity of demand empowers businesses to make informed pricing decisions and helps policymakers predict the impact of tax changes. We encourage readers to apply their knowledge of elasticity in real-world economic situations, from analyzing market trends to predicting consumer behavior. By mastering this concept, you'll gain valuable insights into the dynamics of supply and demand, enhancing your ability to navigate complex economic landscapes and make informed decisions in both personal and professional contexts.
Price Elasticity of Demand Overview:
Definition for Elasticity
- Analyze supply and demand with good precision
- How buyers and sellers respond to change
- Price Elasticity of Demand
- Why is it important
Step 1: Introduction to Elasticity
Welcome to this section. Since we've learned about supply and demand, it's time to talk about elasticity. Elasticity is a crucial concept in economics that helps us analyze supply and demand with great precision. It shows us how buyers and sellers respond to changes in the market. For instance, if the price of a product increases slightly, elasticity helps us understand whether buyers will purchase more or less of the product and how sellers will react. This understanding is essential for making informed economic decisions.
Step 2: Definition of Elasticity
Elasticity measures the responsiveness of the quantity demanded or supplied to changes in price or other factors. In the context of demand, price elasticity of demand specifically measures how much the quantity demanded of a good responds to a change in its price. This concept is vital for businesses and policymakers as it helps predict consumer behavior and adjust strategies accordingly.
Step 3: Calculating Price Elasticity of Demand
To calculate the price elasticity of demand, we use a specific formula. First, we determine the percentage change in the quantity demanded. This involves comparing the quantity demanded before and after a price change. Next, we calculate the percentage change in price by comparing the initial price with the new price. Finally, we divide the percentage change in quantity demanded by the percentage change in price. This calculation gives us the elasticity of demand, which indicates how sensitive the quantity demanded is to price changes.
Step 4: Importance of Price Elasticity of Demand
Understanding price elasticity of demand is crucial for several reasons. It helps businesses set optimal pricing strategies to maximize revenue. For example, if a product has high elasticity, a small price increase could lead to a significant drop in sales, suggesting that the business should avoid raising prices. Conversely, if a product has low elasticity, the business can increase prices without significantly affecting sales volume. Additionally, policymakers use elasticity to predict the impact of taxes, subsidies, and other economic policies on consumer behavior and market outcomes.
Step 5: Practical Applications
Price elasticity of demand has various practical applications. For instance, it helps businesses forecast the effects of price changes on sales and revenue. It also aids in understanding consumer preferences and adjusting marketing strategies accordingly. Moreover, elasticity analysis can inform decisions about product development, inventory management, and competitive positioning. By leveraging elasticity insights, businesses can make data-driven decisions that enhance profitability and market share.
Step 6: Conclusion
In conclusion, price elasticity of demand is a fundamental concept in economics that provides valuable insights into market dynamics. By analyzing how buyers and sellers respond to price changes, businesses and policymakers can make informed decisions that drive economic success. Understanding and applying elasticity principles is essential for optimizing pricing strategies, predicting consumer behavior, and achieving sustainable growth in a competitive market.
FAQs
Here are some frequently asked questions about price elasticity of demand:
1. What is the formula for calculating price elasticity of demand?
The basic formula for price elasticity of demand is: (Percentage change in quantity demanded) / (Percentage change in price). Mathematically, it's expressed as: (ΔQ/Q) / (ΔP/P), where ΔQ is the change in quantity, Q is the initial quantity, ΔP is the change in price, and P is the initial price.
2. How do you calculate arc price elasticity of demand?
Arc price elasticity of demand is calculated using the formula: [(Q2 - Q1) / ((Q2 + Q1) / 2)] / [(P2 - P1) / ((P2 + P1) / 2)], where Q1 and P1 are initial quantity and price, and Q2 and P2 are final quantity and price. This method is more accurate for larger price changes as it uses average values.
3. What is the difference between elastic and inelastic demand?
Elastic demand occurs when the percentage change in quantity demanded is greater than the percentage change in price (elasticity > 1). Inelastic demand is when the percentage change in quantity demanded is less than the percentage change in price (elasticity < 1). Elastic demand is more responsive to price changes than inelastic demand.
4. What factors affect price elasticity of demand?
Key factors include: availability of substitutes, necessity vs. luxury status of the good, proportion of income spent on the good, time frame considered, brand loyalty, market structure, and perceived quality or uniqueness of the product.
5. How does price elasticity of demand affect total revenue?
For elastic goods, a price decrease leads to an increase in total revenue as the increase in quantity demanded outweighs the price reduction. For inelastic goods, a price increase results in higher total revenue as the decrease in quantity demanded is proportionally smaller than the price increase. Understanding this relationship helps businesses optimize pricing strategies.
Prerequisite Topics
Understanding the concept of price elasticity of demand is crucial in economics and business studies. While there are no specific prerequisite topics provided for this subject, it's important to note that a strong foundation in basic economic principles and mathematical concepts can greatly enhance your comprehension of price elasticity of demand.
Price elasticity of demand is a fundamental economic concept that measures how sensitive consumer demand is to changes in price. To fully grasp this concept, students should have a solid understanding of supply and demand principles, as well as basic mathematical skills such as percentages and ratios.
Although not explicitly listed as prerequisites, topics like consumer behavior, market structures, and microeconomic theory provide valuable context for understanding price elasticity of demand. Familiarity with these areas can help students appreciate the broader implications of elasticity in real-world scenarios.
Additionally, a basic understanding of graphing and data interpretation can be beneficial when studying price elasticity of demand. These skills allow students to visualize and analyze the relationship between price changes and quantity demanded, which is at the core of elasticity calculations.
While specific prerequisites are not provided, it's worth noting that economics builds upon itself, with each concept often relying on previously learned material. Therefore, a strong grasp of foundational economic principles will serve as an excellent starting point for delving into price elasticity of demand.
As students progress in their study of price elasticity of demand, they may find it helpful to review related concepts such as cross-price elasticity, income elasticity, and the factors that influence elasticity. These topics often go hand-in-hand with price elasticity of demand and can provide a more comprehensive understanding of consumer responsiveness to price changes.
In conclusion, while there are no specific prerequisites listed for price elasticity of demand, a solid foundation in basic economic principles, mathematical skills, and an understanding of consumer behavior will greatly enhance a student's ability to grasp and apply this important concept. As with many topics in economics, the interconnectedness of various concepts means that a broad understanding of the field will contribute to a deeper appreciation of price elasticity of demand and its implications in the real world.
Definition for Elasticity
Elasticity helps us analyze supply and demand with great precision and shows us how buyers and sellers respond to change.
The elasticity of demand measures the responsiveness of the quantity demanded to a change in the good.
Formulas for Price Elasticity of Demand
Using the formula above, there are two ways to calculate price elasticity of demand.
First Way: Point Elasticity of Demand
Second Way: Arc Elasticity of Demand
Where = and =
Ignore the negative sign when calculating the elasticity, it is unimportant.
Notes about Price Elasticity of Demand
Average Price and Quantity: We use average price and quantity when applying the arc elasticity of demand formula because we get the same elasticity value regardless of whether the price rises or falls. It is also more accurate.
Percentages and Proportions: The ratio of two proportionate changes is the same as the ratio of two percentage changes.
Units-Free Measure: Since Elasticity uses percentages, the change in the units of measurement of price and quantity does not matter.
Types of Elasticities
Inelastic Demand: Quantity demanded does not respond strongly to price changes.
Elastic Demand: Quantity demanded responds strongly to price changes.
Unit Elastic Demand: Quantity demanded responds equally to price changes.
Mathematically, if:
- > 1, then it is elastic, and 1% Change in P results in greater than 1% Change in Q
- < 1, then it is inelastic, and 1% Change in P results in less than 1% Change in Q
- = 1, then it is unit elastic, and 1% Change in P = 1% Change in Q
Two Unique Cases of Demand Curves
Case 1: If a demand curve is perfectly inelastic, then the quantity demanded does not respond to price changes.
Case 2: If a demand curve is perfectly elastic, then the quantity demanded changes infinitely with any price changes.
Total Revenue and Price Elasticity of Demand
Total Revenue = Quantity × Price
- If demand is elastic, then 1% price cut increases the quantity sold by more than 1%. This causes revenues to increase.
- If demand is inelastic, then 1% price cut increases the quantity sold by less than 1%. This causes the revenue to decrease.
- If demand is unit elastic, then 1% price cut increase the quantity sold by 1%. This does not change the revenue.
The goal is to always have unit elastic demand.