Question

Define: a. elasticity of demand b. unit-elastic demand c. inelastic demand d. elastic demand

Short answer

Elasticity of demand measures the response of quantity demanded to a change in price. Unit-elastic demand is when the percentage change in quantity and price are equal, leading to an elasticity of 1. Inelastic demand occurs when the percentage change in quantity demanded is less than the percentage change in price (elasticity < 1), while elastic demand occurs when the percentage change in quantity demanded is greater than the percentage change in price (elasticity > 1).

Step-by-step solution

Define elasticity of demand

Elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good. It's calculated as the percentage change in quantity demanded divided by the percentage change in price.

Define unit-elastic demand

Unit-elastic demand, also known as unitary elastic demand, happens when the percentage change in quantity demanded is exactly equal to the percentage change in price. In this case, the price elasticity of demand is exactly 1.

Define inelastic demand

Inelastic demand describes a situation where the percentage change in quantity demanded is less than the percentage change in price. In this case, the price elasticity of demand is less than 1.

Define elastic demand

Elastic demand occurs when the percentage change in quantity demanded is greater than the percentage change in price. In this case, the price elasticity of demand is more than 1.

Key concepts

Unit-Elastic Demand

When we talk about unit-elastic demand, we are discussing a specific situation in the world of economics where the sensitivity of consumers to price changes is perfectly balanced. Imagine you are a seller, and you decide to increase the price of your product by, say, 10%. If the demand for your product is unit-elastic, the quantity that people will buy decreases by exactly 10% as well. Similarly, if you were to decrease the price by a certain percentage, the quantity sold would increase by that same percentage.

It's like a one-to-one dance between price and demand. The formula to determine this is \( \text{Price Elasticity of Demand} = \frac{\% \text{Change in Quantity Demanded}}{\% \text{Change in Price}} \). For unit-elastic demand, this formula equals 1. What this means in practice is that the revenue you make from selling your product remains constant, no matter how you tweak the price. It's a unique and relatively rare circumstance but important for understanding how consumers react in different scenarios.

Inelastic Demand

Inelastic demand might conjure up images of something stubborn and unmoving, and economically speaking, that's not too far off the mark. When we talk about inelastic demand, we're dealing with products or services that people continue to buy, even when the price goes up. Think of necessities like medication or gas; no matter the price, you often still need to purchase these items.

In the formula \( \text{Price Elasticity of Demand} = \frac{\% \text{Change in Quantity Demanded}}{\% \text{Change in Price}} \), inelastic demand is reflected in a result that is less than 1. This indicates that the percentage change in quantity demanded is smaller than the percentage change in price. For businesses, this can be significant as it suggests that price increases might lead to higher revenues since demand drops only slightly in response to higher prices. It's essential for firms and policymakers to recognize inelastic demand because it can influence pricing strategies and tax policies.

Elastic Demand

Now let's dive into the concept of elastic demand which is sort of the polar opposite of inelastic demand. If inelastic demand is a stubborn mule, then elastic demand is more like a spring, reacting significantly to the pressure of price changes. When a product has elastic demand, small price changes can lead to large changes in the quantity demanded. This behaviour is usually observed in non-essential goods or those with many substitutes available — like luxury items, certain electronics, or, astonishingly, even some types of food.

Using our elasticity formula \( \text{Price Elasticity of Demand} = \frac{\% \text{Change in Quantity Demanded}}{\% \text{Change in Price}} \), elastic demand is identified when the result is greater than 1. This elasticity indicates a highly responsive consumer base, where a price decrease can boost the quantity sold substantially, potentially leading to increased revenue, while a price increase might seriously hurt sales. For companies, understanding elastic demand can help optimize pricing for maximum profitability and competitive positioning — it's a powerful insight into consumer behavior and market dynamics.