Price Elasticity of Demand

Price Elasticity of Demand

• At prices above the mid-point of the demand curve, demand is elastic, and at prices below the mid-point, demand is inelastic.
• Price elasticity of demand is calculated using the formula: (percentage change in quantity demanded) / (percentage change in price).
• The average price and average quantity are used to calculate the percentage changes in price and quantity.

Examples of Price Elasticity

• If the price falls from $25 to $15, the quantity demanded increases from 0 to 20 pizzas an hour, and the price elasticity of demand is 4.
• If the price falls from $10 to $0, the quantity demanded increases from 30 to 50 pizzas an hour, and the price elasticity of demand is 1/4.
• If the price falls from $15 to $10, the quantity demanded increases from 20 to 30 pizzas an hour, and the price elasticity of demand is 1.

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 rise in price doesn't always increase total revenue. It depends on the elasticity of demand:
  • If demand is elastic, a 1% price cut increases the quantity sold by more than 1%, and total revenue increases.
  • If demand is inelastic, a 1% price cut increases the quantity sold by less than 1%, and total revenue decreases.
  • If demand is unit elastic, a 1% price cut increases the quantity sold by 1%, and total revenue remains unchanged.
• The total revenue test can be used to estimate the price elasticity of demand by observing the change in total revenue that results from a price change.

Relationship between Elasticity and Total Revenue

• As the price of a pizza falls from $25 to $12.50, the quantity demanded increases from 0 to 25 pizzas an hour, demand is elastic, and total revenue increases.
• At $12.50 a pizza, demand is unit elastic, and total revenue stops increasing.
• As the price of a pizza falls from $12.50 to zero, the quantity demanded increases from 25 to 50 pizzas an hour, demand is inelastic, and total revenue decreases.

Your Expenditure and Elasticity

• If your demand is elastic, a 1% price cut increases the quantity you buy by more than 1%, and your expenditure on the item increases.