ECON8069 Chap.3 Elasticity and Consumer Surplus
Elasticity and Consumer Surplus
Elasticity measures the percentage response of quantity demanded to a percentage price change, removing the units that make slopes hard to compare. Its magnitude predicts whether the price or quantity effect dominates revenue. Consumer surplus asks a different question: how much willingness to pay remains above the market price.
The chapter connects unit-demand gains, smooth demand curves and the geometry of the area under demand.
Standardise the response
Own-price elasticity divides the percentage change in quantity demanded by the percentage change in price. The sign is normally negative because the variables move in opposite directions.
Classification uses the magnitude: above one is elastic, below one is inelastic and exactly one is unit elastic. The percentage convention must be stated and used consistently.
Translate magnitude into revenue
Revenue combines price and quantity. With elastic demand, quantity changes more than proportionately, so a price cut raises revenue and a price rise lowers it.
With inelastic demand, the price effect dominates. Because elasticity can vary along one curve, this inference belongs to the starting point and proposed change rather than the market forever.
Accumulate gains from trade
A unit-demand buyer gains reservation value minus price when the value is high enough to buy. Adding those gains produces a staircase area under market demand.
Smooth demand extends the same logic by adding very small willingness-to-pay gains over quantity, yielding the familiar area below demand and above price.
Keep the objects distinct
Elasticity is a unit-free response ratio. Consumer surplus is a currency value. Cross-price elasticity describes substitution or complementarity, while income elasticity describes exposure to income changes.
Labelling the numerator, denominator and units before computing prevents these related demand tools from being substituted for one another.
What this chapter covers
- 01
Own-price elasticity and its negative sign
- 02
Elastic, unit-elastic and inelastic demand
- 03
Revenue direction after a price change
- 04
Cross-price and income elasticity
- 05
Reservation values and unit-demand surplus
- 06
Consumer-surplus areas under smooth demand
Worked example · free
Price response and revenue verification
- 2Price rises 10% and quantity falls 15% using the initial values as denominators.
- 2Elasticity is -1.5, so the magnitude 1.5 classifies demand as elastic.
- 2Revenue falls from $20,000 to $18,700, confirming that the quantity effect dominates.
Key terms
- Own-price Elasticity
- The percentage quantity response divided by the percentage change in the good's own price.
- Elastic Demand
- Demand whose quantity response has an elasticity magnitude greater than one.
- Reservation Value
- The highest amount a buyer is willing to pay for a unit.
- Consumer Surplus
- Willingness to pay above price, accumulated across the units purchased.
Elasticity and Consumer Surplus FAQ
Why use elasticity instead of the slope?
A slope changes when measurement units change. Elasticity divides percentage changes and is unit-free, so responsiveness can be compared across products, currencies and market sizes. It still belongs to a particular point or comparison on the curve.
When does a price cut raise revenue?
A price cut raises revenue when demand is elastic because quantity expands more than proportionately. With inelastic demand, quantity expands less than proportionately and the lower price reduces revenue. Direct multiplication is a useful check when levels are available.
What does the consumer-surplus area mean?
It adds the gap between willingness to pay and actual price over all units purchased. On a linear demand curve, that gain is often a triangle bounded by demand, the market price and the traded quantity.
When should I sum surplus rather than use a triangle?
Sum reservation-value gains when the problem gives discrete unit-demand buyers or visible steps. Use geometric area for a continuous inverse demand curve after solving the traded quantity. The two methods express the same willingness-to-pay concept at different levels of aggregation.
Exam move
Practise elasticity in a fixed sequence: calculate both percentage changes with the same convention, divide quantity response by price change, retain the sign and classify with the magnitude. For surplus, solve quantity first and label the choke price. Recompute the area and attach currency units to the final value. Draw one staircase demand from five reservation values and sum every positive value-minus-price gain.
Then lower the price and separate the extra surplus on existing purchases from the gain of any newly admitted buyer. For smooth inverse demand, verify the horizontal quantity and vertical choke-price gap before applying a triangle formula. Always finish elasticity work with a direct revenue multiplication when price and quantity levels are available.
Maintain a small units column beside every result: elasticity has no units, revenue and consumer surplus use currency, and quantity retains the market's physical unit. Compare midpoint and initial-value percentage changes on one data pair so the chosen convention is deliberate and disclosed.
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