TECHNICAL NOTE
For the special cases of perfectly inelastic demand and perfectly elastic demand, the "law of
downward sloping demand" does NOT apply
For a perfectly inelastic demand curve, for example, an increase in price does NOT reduce
quantity demanded
(Price) Elasticity of Demand
Percent change in quantity demanded/ percent change in price
Measures responsiveness of quantity demanded to a change in price (as move along DD curve)
Price Elasticity of Demand and Total Revenue
Total Revenue = Price * Quantity
In response to an increase in price, total revenue:
- increases if demand is inelastic
- is unchanged if demand is unit elastic
-decreases if demand is elastic
Inelastic Demand Curve ( TR ^ if P ^)
TR0 = P0 * Q0 (Revenue at old price) TR1 = P1 * Q1 (Revenue at higher price)
Revenue increase: (P1 - P0) * Q1
Revenue decrease: P0 * (Q0 - Q1)
In this case, revenue increase exceeds revenue decrease, so total revenue rises as price
increases
Intuition
Revenue increases because customers who continue pay a higher price
(P1 - P0) * Q1
Revenue decreases because some customers will not pay a higher price
(P0 * (Q0 - Q1)
If demand is inelastic, most customers continue to pay higher price
If demand is elastic, most customers choose not to pay higher price
Practical Application
1. You own the Toronto Transit Commission (TTC)
2. You own 1 of 5 toll bridges across a river
If you want to increase your total revenue, should you raise the price ( i.e., the TTC fare or the
toll)?
TTC
Few close substitutes, so DD is inelastic
Total revenue increases if you raise price (fare)
One of Five Toll Bridges
(Four) close substitutes, so DD is elastic
Total revenue falls if you raise price (toll)
(Your total revenues would fall to zero if everyone uses one of the other bridges)
Is the Royal Ontario Museum (ROM) being nice to its visitors?
INSIGHT
ROM has discovered, at the current price of admission, the demand curve is elastic
TECHNICAL NOTE (STUDENT EXERCISE)
Elasticity at each point (P,Q) on a linear, downward-sloping demand curve:
Elasticity = P / Q * (1 / slope)
NOTE: key to prob
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