Chapter 4: Elasticity
Price Elasticity of Demand
When supply increases, the equilibrium price falls, and the equilibrium quantity increase. Sometimes this price change
is large and the quantity change is small and other times vice versa. This is because it depends on the responsiveness of
a quantity demanded to a change in price.
Price elasticity of demand: A unit-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 same.
o The change in price and quantity demanded are expressed as percentages of the average price and quantity.
o Is always negative, since when the price of a good rises (+), the quantity demanded decreases (-).
o However, to compare elasticity, only the magnitude of the elasticity is used (negative sign is ignored).
o At a high price and small quantity demanded, elasticity is large.
o At a small price and high quantity demanded, elasticity is small.
o Depends on:
Closeness of substitutes.
Proportion of income spent on the good.
Time elapsed since the price change.
Inelastic demand: A good in which the quantity demanded is less than the % change in price.
Elastic demand: A good in which the quantity demanded exceeds the % change in price.
Perfectly inelastic demand: A good in which the quantity demanded remains constant when the price changes
o Vertical demand curve
o Price elasticity of demand = 0
Unit elastic demand: A good in which the % change in quantity demanded equals the % change in price.
o Mid-point price and quantity demanded.
o Price elasticity of demand = 1
Perfectly elastic demand: A good in which the quantity demanded changes by an infinitely large percentage, in
response to a tiny price change.
o Horizontal demand curve
o Price elasticity of demand = infinity
o When demand is unit elastic, an increase in price results in
An equal percentage decrease in the quantity demanded
Total revenue does not change
o When demand is elastic, an increase in price results in
A higher percentage decrease in the quantity demanded
Total revenue decreases. o When demand is inelastic, an increase in the price results in: