Unit 2: Supply and Demand
2.3: Price Elasticity of Demand
The price elasticity of demand refers to how responsive consumers are to a change in price in the market. It shows us just how much consumers will alter their consumption when the price of a product changes.
Types of Elasticity
There are five types of elasticity for demand: elastic, inelastic, unit elastic, perfectly elastic, and perfectly inelastic.
- Elastic demand means that consumers are very responsive to price changes (i.e. if the price of a product increases, there will be a large decrease in the quantity demanded).
- Inelastic demand means that consumers are not very responsive to price changes (i.e. if the price of a product increases, there will be a small decrease in the quantity demanded).
- Unit elastic demand occurs when consumers are proportionally responsive to changes in market price (i.e. if there is a 30% increase in price then there will be a 30% decrease in quantity demanded).
- Perfectly elastic means that consumers will only produce one price level.
- Perfectly inelastic means that quantity demanded will not change when price level changes.
Graphs of the Different Types of Elasticity
Calculating Price Elasticity of Demand
💡You drop all negatives when you are calculating the elasticity of demand. This formula allows you to calculate the coefficient (a number that tells us the value of elasticity) that represents the elasticity of demand.
The elasticity coefficient you just calculated can be applied to determine the type of demand for that good or service.
💡 Elasticity is NOT the slope of the demand curve. Elasticity varies along a demand curve, even if it is linear.
Elasticity of demand can tell a firm a lot about consumers' buying habits. For example, if a consumer needs a particular medicine to live, then they have very inelastic demand for this product🏥. This tells the firm that they could change the price of the good and the customer will still buy it. On the other hand, a company like Coca-Cola knows that there are a lot of options that their customers could choose from when they purchase soda🥤. This means that the demand for soda is typically more elastic, so Coca-Cola knows they have to be more careful about price changes so they do not lose customers.
Total Revenue Test:
Price Elasticity of Demand can also be calculated using the Total Revenue Test. Total revenue = Price x Quantity.
The total revenue test is used to determine the elasticity of demand when we just want to know whether it is elastic, inelastic, or unit elastic and we do not need the actual coefficient. Firms can use this test to determine its pricing strategy. By being aware of how elastic or inelastic a product is, they have better insight on how to maximize their total revenue. The more elastic demand is for a product, the more cautious they need to be about price changes.