6.1 Graphing Exercise: Elasticity and Revenue

How will consumers respond to a price change? Sales will increase if price falls, but by how much? Will a higher price lead people to buy a substitute instead? And if they do, is it possible that the seller's revenue might actually decrease? The price elasticity of demand, E_d, is a measure of buyer responsiveness to price changes. It equals the ratio of the percentage change in quantity demanded to the percentage change in the price. If the percentage quantity change exceeds the percentage price change, E_d is greater than one (in absolute value) and we say demand is elastic. Demand is inelastic if the quantity change is less than the price change in percents; E_d is less than one. The elasticity of demand varies from one product to another. It may even vary for the same product: demand for a product may be more elastic at high prices than at low prices and is usually more elastic in the long run than in the short run.

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Exploration: How does the elasticity of demand vary along a straight-line demand curve?

The graph illustrates the demand for soft drinks at a large grocery store. At the current price of $3, sales are 3000 cases per week, generating total sales revenue of $9,000. By dragging the triangle on the price axis of the demand curve, you can observe the relationship between the price and quantity demanded while total revenue is updated on the right-hand-side graph. Click on the Elasticity button to calculate the price elasticity over the selected range of the demand curve. Clicking and dragging the demand curve label will change the slope of the demand curve.

1. What is the elasticity of demand over the $4 to $5 price range?
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2. What is the elasticity of demand over the $1 to $2 price range?
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3. Experiment on your own. Over what range of the demand curve is demand elastic? Is there a price range over which E_d is 1, or "unit elastic?"
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4. Select an elastic range of the demand curve. What happens to total revenue when price is increased through this range?
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5. Select an inelastic range of the demand curve. What happens to total revenue when price is increased through this range?
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6. If two demand curves intersect one another, which is the more elastic?
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