Price Elasticity of Demand
Ameasure of the responsiveness of the quantity demanded to a price change.
The price elasticity of demand is a units-free measure of the responsiveness of the quantity
demanded of a good to a change in its price when all other influences on buyers’plans remain the
The price elasticity of demand is calculated by using the formula:
Percentage change in quantity demanded if >1, elastic demand
Percentage change in price if =1, unit elastic demand
if <1, inelastic demand
＝ (new quantity- original quantity) /quantity average
(new price – original price)/ price average
If the quantity demanded doesn’t change when the price changes, the price elasticity of demand is
zero and the good as a perfectly inelastic demand.
Total Revenue and Elasticity
The total revenue ＝price * demand (When the price changes, total revenue also changes. But a
rise in price doesn’t always increase total revenue. )
The change in total revenue due to a change in price depends on the elasticity of demand:
• If demand is elastic, a 1 percent price cut increases the quantity sold by more than 1 percent,
and total revenue increases.
• If demand is inelastic, a 1 percent price cut decreases the quantity sold by less than 1
percent, and total revenues decreases.
• If demand is unit elastic, a 1 percent price cut increases the quantity sold by 1 percent, and
total revenue remains unchanged.
The total revenue test is 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).
• If a price cut increases total revenue, demand is elastic.
• If a price cut decreases total revenue, demand is inelastic.
• If a price cut leaves total revenue unchanged, demand is unit elastic.
The Factors That Influence the Elasticity of Demand
The closeness of substitutes: The closer the substitutes for a good or service, the more elastic are the
demand for it. Necessities, such as food or housing, generally have inelastic demand.
The proportion of income spent on the good: The greater the proportion of income consumers spent
on a good, the larger is its elasticity of demand.
The time elapsed since a price change The more time consumers have to adjust to a price change, or
the longer that a good can be stored without losing its value, the more elastic is the demand for that
Basic needs are always inelastic.
Cross Elasticity of Demand
The cross elasticity of demand is a measure of the responsiven