Question

QUESTION 4

An economist needs a deep understanding of price elasticity concepts and their applicability in today’s economy.

4.1 Define price elasticity of demand and how it is measured.

4.2 Explain the FIVE (5) categories of price elasticity of demand.

4.3 Explain the relationship between the total revenue from the sales of a product and the price elasticity of the demand for the product.

Answer 1

Answer 4.1

Price elasticity of demand is an economic measure of the change in the quantity demanded or purchased of a product in relation to its price change. Expressed mathematically, it is:

Price Elasticity of Demand = % Change in Quantity Demanded / % Change in Price

Price elasticity is used by economists to understand how supply or demand changes given changes in price to understand the workings of the real economy.

Answer 4.2

Five categories of price elasticity of demand are:

1. Perfectly Elastic Demand:
When a small change in price of a product causes a major change in its demand, it is said to be perfectly elastic demand. In perfectly elastic demand, a small rise in price results in fall in demand to zero, while a small fall in price causes increase in demand to infinity. In such a case, the demand is perfectly elastic or ep = 00.

2. Perfectly Inelastic Demand:
A perfectly inelastic demand is one when there is no change produced in the demand of a product with change in its price. The numerical value for perfectly inelastic demand is zero (ep=0).

3. Relatively Elastic Demand:
Relatively elastic demand refers to the demand when the proportionate change produced in demand is greater than the proportionate change in price of a product. The numerical value of relatively elastic demand ranges between one to infinity.

4. Relatively Inelastic Demand:
Relatively inelastic demand is one when the percentage change produced in demand is less than the percentage change in the price of a product. The numerical value of relatively elastic demand ranges between zero to one (ep<1).

5. Unitary Elastic Demand:
When the proportionate change in demand produces the same change in the price of the product, the demand is referred as unitary elastic demand. The numerical value for unitary elastic demand is equal to one (ep=1).

Answer 4.3

If demand is . . .	Then . . .	Therefore . . .
Elastic	% change in Qd is greater than % change in P	A given % rise in P will be more than offset by a larger % fall in Q so that total revenue (P times Q) falls.
Unitary	% change in Qd is equal to % change in P	A given % rise in P will be exactly offset by an equal % fall in Q so that total revenue (P times Q) is unchanged.
Inelastic	% change in Qd is less than % change in P	A given % rise in P will cause a smaller % fall in Q so that total revenue (P times Q) rises.