Lecture Notes: Price Elasticity of Demand Along the Demand Curve

Key Concepts

• Price Elasticity of Demand (PED): Measures the responsiveness of the quantity demanded to a change in price.
• Demand Curve: Graphical representation showing the relationship between the price of a good and the quantity demanded.

Elasticity vs. Gradient

• Gradient:
  • Represents the slope of the demand curve.
  • Constant along a linear demand curve.
• Elasticity of Demand:
  • Varies along the demand curve.
  • Considers percentage changes in quantity demanded and price, unlike gradient.

Elasticity Along the Demand Curve

• Top Half of Demand Curve:

  • Represents elastic demand (PED > 1).
  • Larger percentage changes in quantity demanded compared to price changes.
  • E.g., A price drop from £10 to £9 with quantities increasing from 0 to 1 results in infinite elastic demand.
  • Price drop calculations show elastic demand (e.g., PED of -9 when price drops from £9 to £8).

• Midpoint of Demand Curve:

  • Represents unitary elastic demand (PED = -1).
  • Equal percentage changes in price and quantity demanded.
  • E.g., Price drop from £5 to £4, both price and quantity change by 20%.

• Bottom Half of Demand Curve:

  • Represents inelastic demand (PED < 1).
  • Smaller percentage changes in quantity demanded compared to price changes.
  • E.g., Price drop from £2 to £1 results in a PED of -0.25.
  • Extreme case: Price increase from 0 to 1 leads to perfectly inelastic demand (PED = 0).

Simplified Explanation

• Elastic Section:
  • Percentage change in quantity demanded > Percentage change in price.
• Inelastic Section:
  • Percentage change in quantity demanded < Percentage change in price.

Relationship Between PED and Total Revenue

• Total Revenue (TR): Maximized at point of unit elasticity (midpoint of demand curve).
• Elastic Demand:
  • Lowering prices increases total revenue.
• Inelastic Demand:
  • Lowering prices decreases total revenue.
• Conclusion: To maximize total revenue, prices should be adjusted to achieve unit elasticity.

Visual Representation

• Total Revenue Curve:
  • Peaks at unit elasticity and declines on either side.
  • Demonstrates that revenue increases with elastic demand and decreases with inelastic demand.

Conclusion

Understanding the variation of price elasticity along the demand curve is crucial for explaining demand behavior and its impact on total revenue.