COMM1100 Chap.5 Price Elasticity of Demand and Supply
Price Elasticity of Demand and Supply
Knowing that quantity falls when price rises is not enough for a business decision; the firm needs to know by how much. Price elasticity answers that question.
The Week 2 lecture defines it as the percentage change in quantity divided by the percentage change in price, classifies values as elastic, unit elastic or inelastic, and explains what makes demand and supply more or less responsive.
This chapter applies the point formula to straight-line demand, shows why elasticity changes along a line with a constant slope, and links the classification to revenue: on the elastic stretch a price rise loses revenue, on the inelastic stretch it gains revenue.
The practice questions use exactly this reasoning to judge a proposed price change.
Elasticity also explains why some businesses can raise prices without losing many customers while others cannot. A firm whose product has few substitutes faces less elastic demand, which links this chapter to the market-power ideas of Week 3: the less elastic the demand a firm faces, the more room it has to price above cost.
Keep that connection in mind when you analyse a case.
What this chapter covers
- 01
Elasticity as a ratio of percentage changes
- 02
Elastic, unit elastic and inelastic classifications
- 03
Determinants of demand elasticity
- 04
Determinants of supply elasticity
- 05
The point formula: price over quantity times one over the slope
- 06
Elasticity along a straight demand line
- 07
The revenue test for a price change
Worked example · free
A gym membership price and the revenue test
- +1At $50, Q = 900 − 500 = 400 members.
- +1Quantity changes by 10 per dollar, so |E| = 10 × 50/400 = 1.25: demand is elastic.
- +1At $45, Q = 450 and revenue is 45 × 450 = $20,250, above 50 × 400 = $20,000, so the cut raises revenue, as an elastic demand predicts.
Key terms
- Price elasticity
- The percentage change in quantity divided by the percentage change in price.
- Elastic demand
- Demand whose quantity changes by a larger percentage than price, so the absolute elasticity exceeds 1.
- Inelastic demand
- Demand whose quantity changes by a smaller percentage than price, so the absolute elasticity is below 1.
- Unit elastic
- An elasticity of exactly 1 in absolute value; on a straight demand line it occurs at the midpoint.
- Excess capacity
- Unused productive capacity that lets a seller expand output quickly, making supply more elastic.
Price Elasticity of Demand and Supply FAQ
Why does elasticity change along a straight demand line?
The slope is constant, but elasticity also depends on the ratio of price to quantity. Near the top of the line price is high and quantity low, so demand is elastic; near the bottom the reverse holds, so demand is inelastic.
What makes demand more elastic?
The lecture’s idea is ease of finding an alternative. More time to shop around, more close substitutes, a narrowly defined good and a larger share of the budget all make buyers more responsive to price.
Does measuring quantity in different units change elasticity?
No. Elasticity is built from percentage changes, so switching from bottles to litres, or from dollars to cents, leaves the value unchanged. The Week 2 solutions use this as a challenge question.
How does elasticity tell a manager whether to raise the price?
If demand is inelastic at the current price, a small rise loses proportionally fewer sales than it gains in price, so revenue rises. If demand is elastic, the lost sales outweigh the higher price and revenue falls.
What makes supply more elastic?
Supply is more elastic when sellers can expand output easily: when they have time to adjust, raw materials on hand, finished goods in inventory, or spare capacity in their equipment and workforce. Supply over a longer period is usually more elastic than supply over a few days.
Assessment move
Memorise the point formula in the form you will use it, price over quantity times the change in quantity per dollar, and practise reading that change straight from a demand equation. Work two points on the same line every time so the idea that elasticity varies along a line becomes intuitive.
Finish each calculation with the classification in words and a revenue prediction, and check the prediction with a quick revenue calculation.
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