Lecture 6: Elasticity (Continued)
September 29, 2011
Total Revenue and Elasticity
The total revenue from the sale of a good or service equals the price of the
good multiplied by the quantity sold.
A change in the price always creates a change in the quantity sold, however this
does not always mean an increase in total revenue.
The change in total revenue due to a change in price depends on the elasticity of
If demand is elastic, a 1% price cut increases the quantity sold by more than 1%
and the total revenue increases.
If demand is inelastic, a 1% price cut decreases the quantity sold by more than
1% and the total revenue decreases
If the demand is unit elastic, a 1% cut in the price increases the quantity sold by
1% and the total revenue remains unchanged.
Total Revenue Test
A method of estimating the price elasticity of demand by observing the change in
total revenue that results from a price change, when all other influences on the
quantity sold remain the same.
Your Expenditure and Elasticity
If you demand is elastic, a 1% price cut increases the quantity you buy by more
than 1% and your expenditure on the item increases.
If your demand is inelastic, a 1% price cut increases the quantity you buy by less
than 1% and your expenditure decreases.
If your demand is unit elastic, a 1% price cut increases the quantity you buy by
1%, so your expenditure remains the same.
The Factors the Influence the Elasticity of Demand The closeness of substitutes
- The closer the substitute for a good or service, the more elastic are the
demands for it.
- Necessities, such as food and housing generally have inelastic demand
- Luxuries, such as vacations, generally have elastic demand
The proportion of income spent on the good
- the more you spend on a given good, the more sensitive (or elastic) you will be
to price changes.
The time elapsed since a price change
- the more time you have, the more elastic you are to the price of the good. More
time means you have mo