Theory question 105
Elasticity(a) Define price elasticity of demand.
(b) Distinguish between elastic demand and inelastic demand.
(c) Using diagrams, explain what happens to a trader's total revenue when his price falls, given that demand for his product is: (i) elastic; (ii) inelastic.
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(a) Price elasticity of demand is the degree of responsiveness of quantity demanded to a change in the commodity's own price (% change in Qd ÷ % change in price).
(b) Elastic demand: quantity demanded changes by a larger percentage than price (coefficient > 1). Inelastic demand: quantity changes by a smaller percentage than price (coefficient < 1).
(c)(i) Elastic (flatter curve): a fall in price causes a more than proportionate rise in quantity, so total revenue rises; area OP2RQ2 is larger than OP1TQ1.
(ii) Inelastic (steeper curve): a fall in price causes a less than proportionate rise in quantity, so total revenue falls; the new rectangle is smaller.
Compare the revenue rectangles before and after the price fall.