Definition of Elastic, Inelastic, and Unit Elastic DemandÂ
By definition:
1. A product is elastic when its elasticity is greater than 1.
When a product is elastic and its price changes, the percentage change in quantity demanded is greater than the percentage change in the price. For example, if buyers purchase 20% fewer products as a result of a 10% price increase, then the product is elastic.
2. A product is inelastic when its elasticity is less than 1.
The numerator (percentage change in quantity demanded) of the elasticity formula is less than the denominator (percentage change in price). For example, if buyers purchase 6% fewer products as a result of a 15% price increase, then the product is inelastic.
3. A product is unit elastic when its elasticity is equal to 1.
If a product’s price rises by 8% and its quantity demanded decreases by 8%, then the product is unit elastic.
Elasticity and Revenue
When a product is elastic, and its price rises, what happens to the firm’s total revenue?
A firm’s total revenue is equal to the number of products it sells times the price of the product. Thus:
Total Revenue = Price times Quantity
or TR = P x Q |
For example, if a store sells 30 pairs of shoes at $10 each, then its revenue equals 30 times $10, or $300. If the store sells 20 pairs of shoes after the price increases to $25, then its total revenue equals 20 times $25, or $500. Thus, the store’s total revenue increases.
In the above example, P (the price) increased, so, therefore, Q (the quantity demanded) decreased, and total revenue increased. Does a price increase always lead to total revenue increase? The answer is “no”. It depends on the product’s elasticity. Let’s look at the following example.
A supermarket sells 50 oranges at $1 each. Its revenue equals 50 times $1 or $50. If the store sells 20 oranges after the price increases to $2, then its revenue equals 20 times $2, or $40. Thus, the store’s revenue decreases.
If a product is elastic, the percentage change in the quantity demanded change is greater than the percentage change in the price. Therefore, for an elastic product, if the price increases, the percentage change in the quantity demanded decreases by a greater amount, and the firm’s revenue will decrease, and vice versa.
If a product is inelastic, the percentage change in the quantity demanded change is smaller than the percentage change in the price. Therefore, for an inelastic product, if the price increases, the percentage change in the quantity demanded decreases by a smaller amount, and the firm’s revenue will increase, and vice versa.
In summary:
When a product is elastic and its price falls, total revenue increases.
When a product is elastic and its price rises, total revenue decreases. When a product is inelastic and its price rises, total revenue increases. When a product is inelastic and its price falls, total revenue decreases. When a product is unit elastic and its price changes, total revenue remains constant. |