Economics, 3rd Edition

The Price Elasticity of Demand

The steepness of the demand curve indicates the price elasticity of demand (assuming the scale used on the axes are the same). Note 

that all percentage changes are calculated using the midpoint method.

Th P i

El ti it

FIGURE 4.1

(e) Perfectly elastic demand: Elasticity equals infinity

1. At any price

above 

€4, quantity

demanded is zero.

1. At exactly 

€4,

consumers will

buy any quantity.

Price

Demand

€4

0

Quantity

3. At a price below 

€4,

quantity demanded is infinite.

(c) Unit elastic demand: Elasticity equals 1

Price

Demand

€5

4

0

80    100

Quantity

(d) Elastic demand: Elasticity is greater than 1

Price

Demand

€5

4

0

100

50

Quantity

1. A 22%

increase

in price ...

2.... leads to a 22% decrease in quantity demanded.

2.... leads to a 67% decrease in quantity demanded.

1. A 22%

increase

in price ...

(a) Perfectly inelastic demand: Elasticity equals 0

Price

Demand

€5

4

0

100

Quantity

(b) Inelastic demand: Elasticity is less than 1

Price

Demand

€5

4

0

90    100

Quantity

1. An

increase

in price ...

1. A 22%

increase

in price ...

2.... leaves the quantity demanded unchanged.

2.... leads to an 11% decrease in quantity demanded.

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78  PART 2  SUPPLY AND DEMAND: HOW MARKETS WORK

For businesses, having some understanding of the price elasticity of demand is important in 

decision making. If a firm is thinking of changing price how will the demand for its product react? 

The firm knows that there is an inverse relationship between price and demand but the effect on its 

revenue will be dependent on the price elasticity of demand. It is entirely possible that a firm could 

reduce its price and increase total revenue. Equally, a firm could raise price and find its total revenue 

falling. At first glance this might sound counter-intuitive but it all depends on the price elasticity of 

demand for the product.

If demand is inelastic, as in Figure 4.3, then an increase in the price causes an increase in total expendit-

ure. Here an increase in price from 

€1 to €3 causes the quantity demanded to fall from 100 to 80, and 

so total expenditure rises from 

€100 to €240. An increase in price raises P × Q because the fall in Q is 

proportionately smaller than the rise in P.

We obtain the opposite result if demand is elastic: an increase in the price causes a decrease in total 

expenditure. In Figure 4.4, for instance, when the price rises from 

€4 to €5, the quantity demanded falls 

from 50 to 20, and so total expenditure falls from 

€200 to €100. Because demand is elastic, the reduction 

in the quantity demanded is so great that it more than offsets the increase in the price. That is, an increase 

in price reduces P 

× Q because the fall in Q is proportionately greater than the rise in P.

Although the examples in these two figures are extreme, they illustrate a general rule:

 

●

When demand is inelastic (a price elasticity less than 1), price and total expenditure move in the same 

direction.

 

●

When demand is elastic (a price elasticity greater than 1), price and total expenditure move in opposite 

directions.

 

●

If demand is unit elastic (a price elasticity exactly equal to 1), total expenditure remains constant when 

the price changes.

Economists have attempted to place some estimates on the price elasticity of demand for certain goods – 

these do vary depending on which source you are looking at and the methods used by the researcher but 

Table 4.1 provides a summary of some of these estimates.