quantity demanded of a good is affected by changes in the price of the good,
changes in prices of other goods, changes in income and changes in other
relevant factors. Elasticity is a measure of just how much the quantity
demanded will be affected by a change in price, income, price of other goods
the price of steak increases by 1% and the quantity demanded then falls by
20% we can see there has been a very large drop in the amount demanded in
comparison to the change in price. The price elasticity of demand for steak
is said to be high.
the quantity of steak demanded was to only fall by 0.01%, we can see this is
a fairly insignificant fall in quantity in response to the 1% increase in
price. In this case the price elasticity of demand for steak is low.
can be calculated using the following formula:
percentage change in quantity demanded
percentage change in price
help you remember quantity is on top of price think of the football team QPR).
The table below shows a number of calculations of price elasticity of demand.
change in price
change in quantity
figure are actually negative, but economists 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.
case of unitary elasticity is the curve (known as a rectangular hyperbola).
The perfectly inelastic curve looks like an I and the perfectly elastic curve
looks like an E (without the top!).
these special cases it makes it easier to spot whether a demand curve is
relatively elastic or inelastic. The demand curve on the left is relatively
elastic (as it looks more like the E) and the demand in the centre is
relatively inelastic (as it looks more like an I).
in Elasticity Along the Demand Curve
mentioned earlier that a good is infinitely elastic if a fall in price leads
to an infinite rise in quantity. This must occur if quantity was previously
zero and rises to in response to a fall in price - this can be seen at the
top of the demand curve.
opposite occurs at the bottom of the demand curve leading to an elasticity of
shown on the diagram is the point where elasticity is unitary (equal to one),
this by definition occurs exactly halfway along the demand curve.
elasticity is infinite where the demand curve crosses the price axis, but is
equal to zero when it crosses the quantity axis, then elasticity must change
as you move along the demand curve. Demand is price inelastic if it has a
value less than 1 and elastic if greater than 1, these regions are shown
of elasticity for a business
If the business is producing on
the price elastic section of the demand curve, 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 on
the price inelastic section of the demand curve, a small percentage change in
price leads to a small percentage change in quantity demanded. This will have
the effect of decreasing total revenue when the price is increased and
increasing 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 by economists:
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.
Time. 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