ECON1101 Chap.5 Price Elasticity of Demand
Price Elasticity of Demand
Elasticity of demand turns the slope of demand into a unit-free measure of responsiveness. It defines the standard two-point elasticity and the point elasticity, shows why the raw sensitivity depends on units, and explains why elasticity varies along a straight demand line.
It classifies demand as elastic, inelastic, unit elastic, perfectly elastic or perfectly inelastic, lists the determinants of elasticity, and links elasticity to total revenue so you can predict whether a price change raises or lowers spending. The chapter also explains why the standard measure gives different answers from the two ends of a price change and where the midpoint method fits in.
What this chapter covers
- 01
Percentage changes and the elasticity formula
- 02
Sensitivity versus elasticity
- 03
Point elasticity on a linear demand curve
- 04
Elastic, inelastic and unit elastic demand
- 05
Determinants of price elasticity
- 06
Elasticity and total revenue
Worked example · free
Point elasticity along q = 16 − 2p
- 1Point elasticity is −m × p/q with m = 2.
- 1At $6, q = 4, so ε = −2 × 6/4 = −3.
- 1At $4, q = 8, so ε = −1; at $2, q = 12, so ε = −1/3.
- 1Demand is elastic above the $4 midpoint and inelastic below it.
Key terms
- Price elasticity of demand
- A unit-free ratio comparing the percentage response of quantity demanded with the percentage change in the good’s own price.
- Price sensitivity
- Price sensitivity is the change in quantity per unit change in price, a measure that depends on units.
- Point elasticity
- Point elasticity is the elasticity at a single price and quantity, equal to the sensitivity times price over quantity.
- Perfectly inelastic demand
- Perfectly inelastic demand is demand whose quantity does not respond at all to price, drawn as a vertical line.
- Total revenue
- Total revenue is price times quantity sold, which equals buyers’ total expenditure on the good.
- Elastic demand
- Elastic demand is demand whose quantity changes by a larger percentage than the price, so its elasticity exceeds one in absolute value.
Price Elasticity of Demand FAQ
Why is price elasticity of demand negative?
Under the law of demand price and quantity move in opposite directions, so one percentage change is positive and the other negative. The ratio is therefore negative, and demand is classified using its absolute value.
Why does the standard elasticity change with the starting point?
Each percentage is calculated on the starting value. Moving from $6 to $5.40 uses $6 as the base, while moving back uses $5.40, so the percentages differ and so does their ratio, especially for large price changes.
When does a price rise increase revenue?
When demand is inelastic over that range. The percentage fall in quantity is then smaller than the percentage rise in price, so price times quantity goes up. With elastic demand the quantity response dominates and revenue falls.
What makes demand more elastic?
Close substitutes, a good seen as a luxury rather than a necessity, a large share of the buyer’s budget, and more time to adjust all make buyers respond more strongly to a price change.
What is the difference between perfectly elastic and perfectly inelastic demand?
Perfectly elastic demand is horizontal: buyers take any quantity at one price and none at all above it, as a single competitive firm experiences. Perfectly inelastic demand is vertical: quantity stays the same whatever the price, as with a life-saving drug.
Why does a straight demand line have changing elasticity?
Elasticity depends on the ratio of price to quantity as well as on the slope. Along a straight line the slope is fixed, but price over quantity is large near the top and small near the bottom, so demand is elastic on the upper half and inelastic on the lower half.
Exam move
Memorise the two formulas, then practise on one straight demand line at three prices, computing standard and point elasticities and the revenue at each price. Draw the revenue rectangles for one price rise in the elastic range and one in the inelastic range. Finish by ranking pairs of goods by elasticity and naming the determinant that decides each ranking, because statement questions rarely give numbers.
Add one interpretation sentence to every elasticity you compute, in percentages and with the direction stated, because that sentence earns marks on its own and exposes sign errors immediately.
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