Microeconomics Foundations (ECON 101) · Module 3 of 9
Elasticity in Depth
How responsive buyers and sellers really are to price changes, and what that means for revenue.
Price Elasticity of Demand
- Price elasticity of demand (PED) = % change in quantity demanded ÷ % change in price; a value greater than 1 (in absolute value) means demand is elastic, less than 1 means inelastic.
- Goods with many substitutes, that are luxuries, or that represent a large share of a consumer's budget tend to have more elastic demand.
Why does demand for a specific brand of cereal tend to be more elastic than demand for gasoline?
Solution. A specific cereal brand has many close substitutes — other brands, other cereals — so consumers can easily switch if the price rises; gasoline has few substitutes for most drivers in the short run, making its demand much less responsive to price changes.
Elasticity & Total Revenue
- If demand is elastic, a price increase decreases total revenue, since quantity falls proportionally more than price rises; if demand is inelastic, a price increase increases total revenue.
A company raises its price and its total revenue increases as a result. What does this tell you about the elasticity of demand for its product at that price?
Solution. Demand must be inelastic at that price range — since revenue increased despite the price increase, quantity demanded must have fallen by a smaller percentage than the price rose.
Price Elasticity of Supply
- Price elasticity of supply (PES) = % change in quantity supplied ÷ % change in price; supply tends to be more elastic when producers can easily adjust production or when more time is available to respond.
Why is supply for a good generally more elastic in the long run than in the short run?
Solution. In the long run, producers have more time and flexibility to adjust production — building new factories, hiring more workers, entering the industry — making quantity supplied more responsive to price changes than in the short run, when capacity is more fixed.
Cross-Price & Income Elasticity
- Cross-price elasticity of demand measures how the quantity demanded of one good responds to a price change in another good: positive for substitutes, negative for complements.
- Income elasticity of demand measures how quantity demanded responds to a change in income: positive for normal goods, negative for inferior goods.
If the price of coffee rises and the quantity demanded of tea (a substitute) increases, what does this indicate about the cross-price elasticity between them?
Solution. A positive cross-price elasticity, confirming that coffee and tea are substitutes — as coffee becomes relatively more expensive, consumers shift toward tea instead.
Check yourself
2 of this module's 5 quiz questions. Pick your answers, then check them in the app, with an explanation for every question.
1. What does a price elasticity of demand greater than 1 (in absolute value) indicate?
2. If demand is elastic, what happens to total revenue when price increases?