Computing the Price Elasticity of Demand
1. The formula used to calculate the price elasticity of demand is:
Price elasticity of demand = .Percentage change in price
Percentage change in quantity demanded
a. If the price elasticity of demand is greater than 1 (the numerator is larger than the denominator), demand is elastic.
b. If the price elasticity of demand is equal to 1 (the numerator equals the denominator), demand is unit elastic.
c. If the price elasticity of demand is less than 1 (the numerator is less than the denominator), demand is inelastic.
2. Slope and elasticity
The slope of a demand curve measures the responsiveness of quantity demanded to a change in price, but it is not a units-free measure of this responsiveness and cannot be used to compare the demand curves of different goods.
3. A units-free measure
The percentage change in price and the percentage change in quantity demanded (the denominator and numerator of the elasticity formula) are independent of the units of measurement. As a result, the elasticity formula produces a units-free measure of responsiveness.
Elasticity Along a Linear Demand Curve
Along a straight-line demand curve, the slope is constant, but the elasticity changes.
1. At the midpoint of a linear demand curve, the elasticity equals 1 and demand is unit elastic.
2. Above the midpoint of a linear demand curve, elasticity is greater than 1 and demand is elastic.
3. Below the midpoint of a linear demand curve, elasticity is less than 1 and demand is inelastic.
Total Revenue and Price Elasticity of Demand
1. Total revenue from the sale of a good equals (the price of the good) (the quantity of the good sold).
2. The total revenue test is a method of estimating the price elasticity of demand because the impact of a change in price on total revenue depends on the elasticity of demand.
a. If elasticity is greater than 1, an increase in price decreases total revenue. Price and total revenue change in opposite directions.
b. If elasticity equals 1, an increase in price does not change total revenue.
c. If elasticity is less than 1, an increase in price increases total revenue. Price and total revenue change in the same direction.
Your Expenditure and Your Elasticity of Demand
When the price of a good increases, your expenditure on that good depends on the elasticity of your demand for that good.
a. If your demand is elastic, your expenditure on the good decreases when the price rises.
b. If your demand is unit elastic, your expenditure on the good does not change when the price rises.
c. If your demand is inelastic, your expenditure on the good increases when the price rises.
Applications of the Price Elasticity of Demand
1. Farm Prices and Total Revenue
a. Because the demand for agricultural products is inelastic, a crop failure that boosts the price of an agricultural product increases the total revenue for all farmers taken together.
2. Addiction and Elasticity
a. Nonusers’ demand for addictive goods is elastic, so a tax that results in a moderately higher price leads to a substantially smaller number of people trying a drug.
b. Addicts’ demand is inelastic, so a tax or legislation that results in even a substantial price rise brings only a modest decrease in the quantity demanded and increases addicts’ expenditure on these goods.
1. The formula used to calculate the price elasticity of demand is:
Price elasticity of demand = .Percentage change in price
Percentage change in quantity demanded
a. If the price elasticity of demand is greater than 1 (the numerator is larger than the denominator), demand is elastic.
b. If the price elasticity of demand is equal to 1 (the numerator equals the denominator), demand is unit elastic.
c. If the price elasticity of demand is less than 1 (the numerator is less than the denominator), demand is inelastic.
2. Slope and elasticity
The slope of a demand curve measures the responsiveness of quantity demanded to a change in price, but it is not a units-free measure of this responsiveness and cannot be used to compare the demand curves of different goods.
3. A units-free measure
The percentage change in price and the percentage change in quantity demanded (the denominator and numerator of the elasticity formula) are independent of the units of measurement. As a result, the elasticity formula produces a units-free measure of responsiveness.
Elasticity Along a Linear Demand Curve
Along a straight-line demand curve, the slope is constant, but the elasticity changes.
1. At the midpoint of a linear demand curve, the elasticity equals 1 and demand is unit elastic.
2. Above the midpoint of a linear demand curve, elasticity is greater than 1 and demand is elastic.
3. Below the midpoint of a linear demand curve, elasticity is less than 1 and demand is inelastic.
Total Revenue and Price Elasticity of Demand
1. Total revenue from the sale of a good equals (the price of the good) (the quantity of the good sold).
2. The total revenue test is a method of estimating the price elasticity of demand because the impact of a change in price on total revenue depends on the elasticity of demand.
a. If elasticity is greater than 1, an increase in price decreases total revenue. Price and total revenue change in opposite directions.
b. If elasticity equals 1, an increase in price does not change total revenue.
c. If elasticity is less than 1, an increase in price increases total revenue. Price and total revenue change in the same direction.
Your Expenditure and Your Elasticity of Demand
When the price of a good increases, your expenditure on that good depends on the elasticity of your demand for that good.
a. If your demand is elastic, your expenditure on the good decreases when the price rises.
b. If your demand is unit elastic, your expenditure on the good does not change when the price rises.
c. If your demand is inelastic, your expenditure on the good increases when the price rises.
Applications of the Price Elasticity of Demand
1. Farm Prices and Total Revenue
a. Because the demand for agricultural products is inelastic, a crop failure that boosts the price of an agricultural product increases the total revenue for all farmers taken together.
2. Addiction and Elasticity
a. Nonusers’ demand for addictive goods is elastic, so a tax that results in a moderately higher price leads to a substantially smaller number of people trying a drug.
b. Addicts’ demand is inelastic, so a tax or legislation that results in even a substantial price rise brings only a modest decrease in the quantity demanded and increases addicts’ expenditure on these goods.
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