After studying chapter 5, you MUST be able to

define price elasticity of demand

state the meaning of demand elasticity

calculate the price elasticity of demand

state the different types of price elasticity of demand and sketch the corresponding demand curves

state the meaning of different types of price elasticity of demand

state the relationship between price elasticity of demand and total revenue ( refer to the model answer )

state how the factors affect the value of price elasticity of demand

define supply elasticity

state the different types of supply elasticity

state how factors affect the value of supply elasticity

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Change in Total Revenue

When the question concerns about the change in total revenue (= total expenditure = total market value ), you should think about

how the price changes

how the quantity transacted changes

Case One

If both change in the same direction, change in total revenue can be easily determined : Total revenue = price * quantity transacted e.g. P increases, Q_t increases, total revenue will increase

e.g. When there is a change in demand

If demand curve shifts to the right, equilibrium price and quantity will both increase, total revenue will increase

If demand curve shifts to the left, equilibrium price and quantity will both decrease, total revenue will decrease

Case Two

If they change in opposite direction ( one increases while the other decreases ), then the total revenue can only be determined with the information of demand elasticity. In most times you have to decide on your own

e.g. change in supply / only a change in its own price

First identify the demand is elastic or inelastic by finding the relationship between the change in price and change in TR

Sketch a diagram showing a demand curve with a suitable slope - sketch a steeper demand curve for inelastic demand ( Note : this is only for more obvious illustration, the value of elasticity is in fact not related to the slope of the demand curve )

It is not necessary to sketch the supply curve unless information about the supply curve is clearly specified in the question

label the demand curve : show the gain and lose on the diagram

Write down the description

e.g. demand is inelastic

when price increases,

-percentage increase in price is greater than the percentage decrease in quantity demanded

-gain in revenue resulting from the increase in price is greater than the loss in revenue resulting from the decrease in quantity demanded

��������� -total revenue increases

Case Three

If only one variable changes ( price or quantity transacted ), total revenue can also be easily determined.

(i) Fixed supply ; increase in demand (ii) Fixed price, increase in demand

��� -Q_t remains unchanged ; P increases Q_t remains unchanged ;

��� -TR = Q_t * P ; TR increases P remains unchanged

��� -TR remains unchanged

(iii) Fixed price ; increase in supply

��� -Q_t increases ; P remains unchanged

��� -TR = P * Q_t ; TR increases

Points to be noted

�� ���� � -Demand elasticity is a number which reflects how the quantity demanded changes ( NOT change in ����������� demand ) in respond to changes in prices

-The change in quantity demanded and the change in price are both measured by the percentage���� change, not changes in magnitude

-Demand elasticity = ( % change in quantity demanded / % change in price )

-Suppose demand elasticity is 2, it means that the Q_d will increase ( decrease ) 20% when price decrease ( increase ) 10%

-Suppose demand elasticity is 0.5, it means that the Q_d will increase ( decrease ) 5% when price decrease ( increase ) 10%

-Demand is more elastic does not mean demand is elastic. It only menas that the value of demand elasticity increases.

e.g. demand elasticity increases from 0.5 to 0.8 and it is more elastic than before but it is still inelastic, demand elasticity increases from 1.5 to 1.9 and it is more elastic than before and it is elastic in both times.

Similarly, demand is more inelastic does not mean demand is inelastic

-Given a percentage change in price

-The greater the % change in quantity demanded ( e.g. more substitutes ), the more elastic the demand

-The smaller the % change in quantity demanded ( e.g. a necessity ), the more inelastic the demand

-No change in quantity demanded, demand is perfectly inelastic

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