Theory question 106
Elasticity(a) Distinguish between the following pairs of concepts: (i) elastic demand and inelastic demand; (ii) income elasticity of demand and cross elasticity of demand.
(b) Using diagrams, explain how an increase in price will affect the total revenue of a producer if demand for his product is: (i) price elastic; (ii) price inelastic.
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(a)(i) Elastic demand: a change in price causes a more than proportionate change in quantity demanded (coefficient > 1). Inelastic demand: a change in price causes a less than proportionate change in quantity demanded (coefficient < 1).
(ii) Income elasticity: responsiveness of quantity demanded to a change in consumers' income (% change in Qd ÷ % change in income). Cross elasticity: responsiveness of quantity demanded of one good to a change in the price of another good (% change in Qd of X ÷ % change in price of Y).
(b)(i) Elastic demand (flat curve): a price rise causes a larger proportionate fall in quantity, so total revenue falls; show the revenue rectangles before and after.
(ii) Inelastic demand (steep curve): a price rise causes a smaller proportionate fall in quantity, so total revenue rises; show the rectangles.
Total revenue = price × quantity; compare the two rectangles.