Holt 7525-9 S15_IT

Example 4F: What is price elasticity of demand if price changes from $2 to $1?
Q 2 – Q 1 80– 70 10
(Q 2 + Q 1 )/2 (80+ 70)/2 75 .1333
E D = ————— = —————— = —— = ——— = .20
P 2 – P 1 1– 2 1 .6667
(P 2 + P 1 )/2 (1 + 2)/2 1.5
Price Elasticity of Demand Classifications
If E D is greater than one, demand is elastic.
If E D is less than one, demand is inelastic.
If E D equals one, demand is unitary elastic.
Price Elasticity of Demand and Total Revenue
One of the uses of price elasticity of demand information is to predict how a change in price will
affect total revenue.
Total Revenue = Price x Quantity
If demand is elastic (E D > 1), price and total revenue are inversely related. An increase in price
will cause a decrease in total revenue, and a decrease in price will cause an increase in total
revenue.
If demand is inelastic (E D < 1), price and total revenue are directly related. An increase in price
will cause an increase in total revenue, and a decrease in price will cause a decrease in total
revenue.
If demand is unitary elastic (E D
= 1), a change in price does not change total revenue.
The table below, based on Examples 4A – 4F, illustrates the relationship between price elasticity
of demand and total revenue. Notice that when demand is elastic, a decrease in price causes an
increase in total revenue, when demand is inelastic, a decrease in price causes a decrease in
total revenue, and when demand is unitary elastic, a decrease in price does not change total
revenue.
Change in
E D from
Price Quantity Total Revenue Total Revenue previous price
$7 20 $140 X X
6 30 180 $40 2.60
5 40 200 20 1.57
4 50 200 0 1.00
3 60 180 -20 .64
2 70 140 -40 .38
1 80 80 -60 .20
Determinants of Price Elasticity of Demand
The determinants of price elasticity of demand are the factors that determine whether the demand
for a good is elastic or inelastic. The four determinants of price elasticity of demand are:
FOR REVIEW ONLY - NOT FOR DISTRIBUTION
1. The number of substitutes for the good. The more substitutes for a good, the more elastic
the demand for the good. The fewer substitutes for a good, the less elastic the demand for the
good.
Elasticity 17 - 4