price elasticity of demand (PED)
PED = % change in Qd / % change in P. Measures how sensitive quantity demanded is to a price change.
elastic demand
|PED| > 1. Quantity is very sensitive to price. Small price change → large quantity change.
inelastic demand
|PED| < 1. Quantity is not sensitive to price. Large price change → small quantity change.
PED formula using a demand function
PED = (dQ/dP) × (P/Q). dQ/dP is just the coefficient of P in the demand function.
total revenue when price rises and demand is elastic
Total revenue falls. Loss from fewer customers outweighs gain from higher price.
total revenue when price rises and demand is inelastic
Total revenue rises. Gain from higher price outweighs loss from fewer customers.
total revenue when demand is unit elastic
Total revenue stays the same regardless of price change.
factors that make demand more elastic
Many substitutes, luxury good, large share of income, long time to adjust.
factors that make demand more inelastic
Few substitutes, necessity, small share of income, short time to adjust.
income elasticity of demand
% change in Qd / % change in income. Positive = normal good. Negative = inferior good.
cross-price elasticity of demand
% change in Qd of good A / % change in price of good B. Positive = substitutes. Negative = complements.
If PED = −2 and price rises by 10%, what happens to quantity?
% change in Qd = −2 × 10% = −20%. Quantity falls by 20%.
elasticity change along a linear demand curve as price rises
Becomes more elastic (more negative). More inelastic at lower prices.
government tax inelastic goods to maximize revenue
Quantity barely falls when price rises → large tax revenue with little reduction in transactions.
effect of a per-unit tax on sellers
Replace P with (P−t) in supply function. Supply shifts left. Buyer price rises, seller price falls, quantity falls.
effect of a subsidy on producers
Replace P with (P+s) in supply function. Supply shifts right. Buyer price falls, quantity rises.
who bears more of the tax burden
The inelastic side. They can’t adjust behaviour easily so absorb more of the tax.
calculate consumer tax incidence
(Rise in buyer price / total tax) × 100.
perfectly elastic demand
PED = −∞. Demand curve is horizontal. Any price rise → quantity drops to zero.
perfectly inelastic demand
PED = 0. Demand curve is vertical. Quantity doesn’t change regardless of price.
Calculate PED: price rises from €10 to €12, quantity falls from 1000 to 900
%ΔQ = −10%. %ΔP = 20%. PED = −10/20 = −0.5. Inelastic.
price elasticity of supply
PES = % change in Qs / % change in P. Always positive since supply slopes upward.
Tax = €5, buyer price rises by €3. What does the seller receive and what is consumer incidence?
Seller receives buyer price − €5. Consumer incidence = 3/5 = 60%.
difference between tax incidence and legal tax liability
Legal liability = who pays government. Incidence = who bears the economic burden. These can differ.
