change in price
change in quantity
figure are actually negative, but we forget this point in the name of
and Inelastic Demand
values of price elasticity are given special names:
Demand is price elastic, if the
value of elasticity is greater than one. If demand for a good is price
elastic then a percentage change in price will lead to an even larger
percentage change in the quantity demanded. For example if a 10% rise in the
price of CDs leads to a 20% fall in the demand, then price elasticity is 20%
/ 10% or 2 and the demand for CDs is therefore elastic.
Demand is price inelastic, if
the value of elasticity is less than one. If the demand for a good is
inelastic then a percentage change in the price will bring about a smaller
percentage change in the quantity demanded. For example if a 10% rise in
price by rail company resulted in a 1% fall in train journeys made then price
elasticity would be 1% / 10% or 0.1 and the demand for rail journeys is
Cases of Elasticity
Demand is infinitely inelastic
if the value of elasticity is zero (zero divided by any number). Any change
in price would have no effect on the quantity demanded.
Demand has unitary elasticity
if the value of elasticity is exactly 1. This means that a percentage change
in the price of a good will lead to an exact and opposite change in the
quantity demanded. For example a good would have unitary elasticity if a 10%
increase led to a 10% fall in the quantity demanded.
Demand is infinitely elastic if
the value of elasticity is infinity (any number divided by zero). A fall in
price would lead to an infinite increase in quantity demanded (i.e.
increasing from zero), whilst an increase in price would lead to the quantity
demanded falling to zero.
of elasticity for a business
If the business is producing a
price elastic good, a small percentage change in price leads to a large
percentage change in quantity demanded. Lowering the price will have the
effect of increasing total revenue and raising the price will decrease total
revenue, e.g., if the price of Mars Bars increased by 25% ceteris paribus, we
would expect their sales to fall dramatically as consumers shift to other
chocolate bars. This would have the effect of reducing their total revenue.
If the business is producing on
the unitary price elasticity section of the demand curve, small changes in
price do not change total revenue as a percentage change in price will be
exactly offset by an inverse change in quantity.
If the business is producing a
price good, a small percentage change in price leads to a smaller percentage
change in quantity demanded. This will have the effect of increasing total
revenue when the price is increased and decreasing total revenue when the
price falls. For example if a firm invented a miracle cure for the common
cold and decided upon a price of 50p a pack. The firm sold 10 million packs
in the first year of sales. Next year they decide to raise prices by 25% and
sales fall to 9 million (10% fall), the level of sales have dropped, but the
total revenue has increased.
is important to note that the revenue maximising level of production occurs
when elasticity is unitary, but this isn't necessarily the level where profit
is maximised. We don't know the firm's costs at different levels of output.
Furthermore elasticities are notoriously difficult to calculate and errors in
the elasticity figures could lead to incorrect pricing decisions.
Affecting the Price Elasticity of Demand
factors are usually highlighted:
The availability of
substitutes. If a product has many substitutes then its price elasticity is
likely to be high. An increase in price will lead to consumers shifting
demand to one of its many substitutes (e.g., chocolate bars). However if the
good has few substitutes, consumers will find it harder to replace that good,
so its price elasticity is likely to be low (e.g. salt). The more widely a product is defined the fewer substitutes it
is likely to have. Spaghetti has many substitutes, but food has none.
The longer the period of time, the more price elastic is the demand for the
product. For example if the price of leaded petrol was to increase by 50% my
demand for it would not change in the shirt run. However as time goes on I
would change my car to one that used unleaded petrol, therefore in the
longrun elasticity becomes greater.