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Chapter 6.1
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Price elasticity of demand
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In this chapter, you are going to learn

1. Sellers’ consideration over selling price

2. Meaning of Price elasticity of demand

3. Relationship between price elasticity and total revenue

➢ State and explain the relationship among price change, price elasticity and total revenue

4. Calculate the (arc) price elasticity of demand (the average price and quantity method)

5. Factors affecting price elasticity of demand

➢ Price ranges
➢ Availability of substitutes
➢ Degree of necessity
➢ Time
➢ Durability
➢ Proportion of total expenditure spent on the good
➢ Number of uses

6. Types of questions

Supplementary readings:
New Senior Secondary Exploring Economics (Third Edition) Book 1:
5.1 Price elasticity of demand
5.2 Types of price elasticity of demand
5.3 Price elasticity of demand and total revenue
5.4 Factors affecting price elasticity of demand

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 1. Sellers’ consideration over setting price

Being a seller, a very important target is to reach a higher total revenue.

➢ Some sellers choose to increase their revenue by raising the price (or reducing the supply).
➢ Some producers may choose to increase their revenue by lowering their price (or increasing the supply).

Why raising the price and lowering the price can both achieve higher total revenue?

Sellers lower the price Sellers raise the price

P P

P1 P2
- P1
+
P2 -
+ D1 - D1

Q Q
Q1 Q2 Q2 Q1

Supply increases Supply decreases

P S1 P S2
S2 S1

P1 P2
- P1
+
P2 -
+ D1 - D1

Q Q
Q1 Q2 Q2 Q1

Supply↑ P↓ Q↑ Change in TR and TE is uncertain

Supply↓ P↑ Q↓ Change in TR and TE is uncertain

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Price, Quantity and Total revenue

Price x Quantity = Total revenue

If sellers raise the price (or price increases because of a decrease in supply), quantity demanded for the good will
decrease, vice versa.

Price ↑ x Quantity ↓ = Total revenue ↑ / ▬ / ↓

Price ↓ x Quantity ↑ = Total revenue ↑ / ▬ / ↓

As Price and Quantity demanded changes in opposite direction, change in total revenue is uncertain. In order to find
out whether total revenue increases or decreases, we need to compare the % change in Price and the % change in
Quantity demanded.

There are 3 situations,

1. % Change in P > % Change in Qd
2. % Change in P = % Change in Qd
3. % Change in P < % Change in Qd

Why compare the change in % but not change in absolute value?

❖ It is because the “unit” of Price and Quantity is different.

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1. % Change in P > % Change in Qd

Price ↑↑ x Quantity ↓ = Total revenue ↑

Price ↓↓ x Quantity ↑ = Total revenue ↓

If % change in P > % change in Q, then change in TR will follow the change in P.

2. % Change in P = % Change in Qd

Price ↑ x Quantity ↓ = Total revenue −−

Price ↓ x Quantity ↑ = Total revenue −−

If % change in P = % change in Q, then TR will remain unchanged.

3. % Change in P < % Change in Qd

Price ↑ x Quantity ↓↓ = Total revenue ↓

Price ↓ x Quantity ↑↑ = Total revenue ↑

If % change in P < % change in Q, then change in TR will follow the change in Qd.

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 2. Meaning of Price elasticity of demand

Price elasticity of demand (價格需求彈性) measures the responsiveness of quantity demanded (Qd) (responsiveness
of consumers) of a good or service to a change in its price (P).

1 Elasticity = reaction or responsiveness

2 Who’s reaction? Consumer’s reaction

3 React to what? React to a change in price (caused by producers or a change in supply)

How can we know whether the

4 Comparing % change in quantity demanded and % change in price
reaction is large or small?

Basic Concept

Raising price will lead to a decrease in quantity demanded while lowering price will lead to an increase in quantity
demanded.

When a firm decides whether to raise or to lower the price of its product, it has to consider the impact of the price
change to consumers’ quantity demanded of the product. Economists use price elasticity of demand to measure the
responsiveness of consumers’ quantity demanded (i.e. responsiveness of customers) to a change in price.

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Customers may have 5 types of reactions to a change in price

Example: If the price of fish ball in school tuck shop increases, students may have following responsiveness.

1. Buy a lot less

2. Buy a few less
3. Buy normal less
4. Buy the same quantity as before
5. Do not buy anymore

Students’ responsiveness Informal name Formal economic name

1 Buy a lot less Large reaction Elastic
2 Buy a few less Small reaction Inelastic
3 Buy normal less Normal reaction Unitary elastic
4 Buy the same quantity as before No reaction Perfectly inelastic
5 Do not buy anymore Unlimited reaction Perfectly elastic

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 3. Relationship between Ed and TR

Suppose the good that we concern is Good X in the following examples.

Change in TR caused by a change in price under following situations

1. Elastic demand
2. Inelastic demand
3. Unitary elastic demand
4. Perfectly inelastic demand
5. Perfectly elastic demand

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Case_1_Elastic demand → % Change in Qd > % Change in Price

P P
S1
S2
P2 P1
+ -
P1 - D P2 - D

- +

Q Q
Q2 Q1 Q1 Q2

When price increases (or there is a decrease in When price decreases (or there is an increase in
supply that leads to an increase in price), supply that leads to an increase in price),

1 When price ↑, quantity demanded will ↓. 1 When price ↓, quantity demanded will ↑.
2 If demand for Good X is elastic, 2 If demand for Good X is elastic,
3 % ↑ in price < % ↓ in quantity demanded, 3 % ↓ in price < % ↑ in quantity demanded,
4 Therefore total revenue will decrease. 4 Therefore total revenue will increase.

To conclude, when the demand is elastic, change in TR follows the change in Q.

Price ↑ x Quantity ↓↓ = Total revenue ↓

Price ↓ x Quantity ↑↑ = Total revenue ↑

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Case_2_Inelastic demand → % Change in Qd < % Change in Price

P P S1

S2
P2 P1

+ -
P1 P2

- D + D
Q Q
Q2 Q1 Q1 Q2

When price increases (or there is a decrease in When price decreases (or there is an increase in
supply that leads to an increase in price), supply that leads to an increase in price),

1 When price ↑, quantity demanded will ↓. 1 When price ↓, quantity demanded will ↑.
2 If demand for Good X is inelastic, 2 If demand for Good X is inelastic,
3 % ↑ in price > % ↓ in quantity demanded, 3 % ↓ in price > % ↑ in quantity demanded,
4 Therefore total revenue will increase. 4 Therefore total revenue will decrease.

To conclude, when the demand is inelastic, change in TR follows the change in P.

Price ↑↑ x Quantity ↓ = Total revenue ↑

Price ↓↓ x Quantity ↑ = Total revenue ↓

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Case_3_Unitary elastic demand → % Change in Qd = % Change in Price

P P S1

S2
P2 P1

+ -
P1 P2
D D
- +
Q Q
Q2 Q1 Q1 Q2

When price increases (or there is a decrease in When price decreases (or there is an increase in
supply that leads to an increase in price), supply that leads to an increase in price),

1 When price ↑, quantity demanded will ↓. 1 When price ↓, quantity demanded will ↑.
2 If demand for Good X is unitary elastic, 2 If demand for Good X is unitary elastic,
3 % ↑ in price = % ↓ in quantity demanded, 3 % ↓ in price = % ↑ in quantity demanded,
4 Therefore total revenue remains unchanged. 4 Therefore total revenue remains unchanged.

To conclude, when the demand is unitary elastic, TR will remain unchanged.

Price ↑ x Quantity ↓ = Total revenue --

Price ↓ x Quantity ↑ = Total revenue --

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Case_4_Perfectly inelastic demand → there is no change in Qd

P D P D
S1

P1 S2
P2

+ -
P1 P2

Q Q
Q Q

If price elasticity of demand is perfectly inelastic,

Change in price will not lead to any change in quantity demanded.
Therefore, increase in price will lead to increase in total revenue.
Therefore, decrease in price will lead to decrease in total revenue.

Case_5_Perfectly elastic demand → a small change in P will lead to an infinite change in Q

P D

If price elasticity of demand is perfectly elastic,

When there is an increase in price, quantity demanded will decrease to zero. → Total revenue become 0.
When there is a decrease in price, quantity demanded will increase to infinity. i.e. goods will be sold out.
→ Total revenue increases.
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 4. Calculate the price elasticity of demand

% change in quantity demanded

Price Elasticity of Demand =
% change in price

%△Qd
Price Elasticity of Demand =
%△P

If PED or Ed = 5, that means if price change by 1%, then quantity demanded will change by 5%.

Beside, as along the same period demand curve, Price and Quantity demanded must change in opposite direction,
therefore price elasticity demand is always negative

For example, if Ed = -2, it means

❖ When price increase by 1%, quantity demanded will decrease by 2%
❖ When price decrease by 1%, quantity demanded will increase by 2%

5 types of Elasticity

5 types of Elasticity Meaning Elasticity

1 Elastic %ΔQd > %ΔP Ed > 1
2 Inelastic %ΔQd < %ΔP Ed < 1
3 Unitary elastic %ΔQd = %ΔP Ed = 1
4 Perfectly inelastic %ΔQd = 0 Ed = 0
5 Perfectly elastic %ΔQd = ∞ Ed = ∞

➢ Δ = change in
➢ %ΔQd = percentage change in quantity demanded
➢ %ΔP = percentage change in price
➢ As Ed must be negative, when saying whether it is elastic or not, we will ignore the negative sign.

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 Point elasticity Vs Arc elasticity

There are two methods to calculate the elasticity of demand for a good.
1. Point elasticity of demand
2. Arc elasticity of demand

However, students are required to learn Arc elasticity,

Point elasticity of demand (not required in HKDSE)

QdNEW – QdOLD
x 100%
QdOLD
Price Elasticity of Demand =
PNEW – POLD
x 100%
POLD

Arc elasticity of demand (required in HKDSE)

QdNEW – QdOLD
x 100%
(QdNEW + QdOLD) / 2
Price Elasticity of Demand =
PNEW – POLD
x 100%
(PNEW + POLD) / 2

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Example

8
6
D

Q
20 40

Arc elasticity of demand → from $6 to $8

20 – 40
x 100% – 66.67%
(40 + 20) / 2
Price Elasticity of Demand = = = – 2.33
8–6
x 100% 28.57%
(8 + 6) / 2

Arc elasticity of demand → from $8 to $6

40 – 20
x 100% 66.67%
(40 + 20) / 2
Price Elasticity of Demand = = = – 2.33
6–8
x 100% – 28.57%
(8 + 6) / 2

Points to note

As along the same demand curve, Price and Quantity demanded must change in opposite direction, therefore price
elasticity of demand is always negative. Therefore, when saying whether it is elastic or not, we will ignore the
negative sign, i.e. E = -2.33 = 2.33 = elastic.

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Exercise 1

10

D
Q
50 60

Find arc elasticity of demand over price range $6 to $10

Exercise 2

Price ($) 1 2 4
Quantity demanded 100 40 10

Find arc elasticity of demand over price range $1 to 2

Find arc elasticity of demand over price range $2 ro $4

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Exercise 3

Price ($) 1 2 4
Total revenue 100 100 100

Find arc elasticity of demand over price range $1 to 2

Find arc elasticity of demand over price range $2 to $4

Find arc elasticity of demand over price range $1 to $4

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Price elasticity of demand along a linear demand curve

PED >1

PED <1
PED =1

Along a linear demand curve, the elasticity of demand varies over different price ranges. In addition, the higher the
price of a good or service, the higher is the price elasticity of demand for it.

Points to note
1. In the range above the mid-point of the demand curve, PED is greater than 1, which means demand is elastic.
2. At the mid-point of demand curve, PED is equal to 1, which means demand is unitarily elastic.
3. In the range below the mid-point of the demand curve, PED is less than 1, which means demand is inelastic.

P P

P2
+
P1

- P2
+
P1
D - D
Q Q
Q2 Q1 Q2 Q1

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Exercise

1
D
Q
1 2 3 4 5

Find arc elasticity of demand over price range $1 to $2

Find arc elasticity of demand over price range $2 to $3

Find arc elasticity of demand over price range $3 to $4

Find arc elasticity of demand over price range $4 to $5

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Exercise

Ed > 1

% change in Price % change in Qd

% change in Price % change in Qd Change in TR

↑ ↓↓
1
↓ ↑↑

If demand is elastic,

When Price increases, Total revenue will .

When Price decreases, Total revenue will .

Ed < 1

% change in Price % change in Qd

% change in Price % change in Qd Change in TR

↑↑ ↓
2
↓↓ ↑

If demand is inelastic,

When Price increases, Total revenue will .

When Price decreases, Total revenue will .

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Exercise

Ed = 1

% change in Price % change in Qd

% change in Price % change in Qd Change in TR

↑ ↓
3
↓ ↑

If demand is unitary elastic,

When Price increases, Total revenue will .

When Price decreases, Total revenue will .

Ed = 0

% change in Qd = .

% change in Price % change in Qd Change in TR

↑
4
↓

If demand is Perfectly inelastic,

When Price increases, Qd will and Total revenue will .

When Price decreases, Qd will and Total revenue will .

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Exercise

Ed = ∞

% change in Qd = .

% change in Price % change in Qd Change in TR

↑
5
↓

If demand is Perfectly elastic,

When Price increases, Qd will and Total revenue will .

When Price decreases, Qd will and Total revenue will .

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Conclusion

Change in
% change in Price % change in Qd
TR or TE

↑ ↓↓ ↓
Ed > 1
1
(Elastic)
↓ ↑↑ ↑

↑↑ ↓ ↑
Ed < 1
2
(Inelastic)
↓↓ ↑ ↓

↑ ↓ ─
Ed = 1
3
(Unitary elastic)
↓ ↑ ─

↑ ─ ↑
Ed = 0
4
(Perfectly inelastic)
↓ ─ ↓

↑ ↓∞ 0
Ed = ∞
5
(Perfectly elastic)
↓ ↑∞ ↑

Conclusion

❖ If a newspaper publisher raises the price of newspaper by $1, the sales volume decreases by 10,000 pieces. What
is consumers’ price elasticity of demand for the newspaper? Elastic?

❖ Mary said, ‘I love to take photos very much. Even though the price of film has increased by 30%, my spending
on it will still be the same. ‘What is Mary’s elasticity of demand for film?

❖ Joyce said, ‘I love drink coffee and will drink 1 cup of coffee every day. Even though the price of coffee has
increased by 30%, I will still buy 1 cup of coffee every day.’ What is Joyce’s elasticity of demand for coffee?

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 5. Factors affecting price elasticity of demand

The following factors will affect the “extent” of consumer’s responsiveness.

1. Price range
The higher the price, the higher the price elasticity of demand for it is.
The lower the price, the lower the price elasticity of demand for it is.

2. Availability of substitutes
The more substitutes, the higher is the price elasticity of demand. This is because consumers can easily shift demand
to substitutes when price of a good increases. i.e. decrease in quantity demanded is large.

Conversely, the fewer substitute, the lower the price elasticity of demand. This is because it is difficult for consumers
to find a substitute when price of a good increases. i.e. decrease in quantity demanded is small.

3. Degree of necessity
Price elasticity for necessities (e.g. water / rice) is lower. This is because they see it as more essential to daily living.

Price elasticity for goods having low degree of necessity (e.g. Luxuries) is higher. This is because they see it as less
essential.

4. Length of time period

The longer the period of time is after a price change, this higher the price elasticity of demand is for a good or service.
This is because consumers have more time to adjust their consumption patterns or find substitutes.

Conversely, in the immediate period after a price change, consumers often find it difficult to adjust their consumption
patterns or find substitutes, and thus the price elasticity of demand is lower.

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5. Durability of a good
The more durable the good is, the higher the price elasticity of demand for it.

Price elasticity of demand for non-durable goods is lower.

As it is non-durable, even if there is a price cut, people will not buy so many as such goods cannot be kept so long.

Price elasticity of demand for durable goods is higher.

As it is durable, if there is a price increase, people can keep the old one and delay the purchase of new one.

6. Proportion of income spent on a good

The smaller the proportion of income spent on a good or service (e.g. sugar / salt), the lower the price elasticity of
demand. This is because a price change in the good has a smaller effect on income.

Conversely, the larger the proportion of income spent on a good or services, the higher the price elasticity of demand.
It is because a slight change in the price of the good results in a greater impact on income.

7. Number of uses
A good (e.g. timber) with more uses (e.g. paper-making, construction of house and furniture-making) tend to have a
higher price elasticity of demand because price change in the good will cause different groups of consumers to
respond to it.

Price elasticity for goods with single use is lower as only a certain group of consumers will react to the price change of
it.

8. Consumer preferences and habits

When consumers have a strong preference for a good or a brand, price elasticity of demand for such good
will be lower. As even if there is an increase in price, such consumers may not switch to other substitutes.

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1994_Q.11b

Suppose a typhoon destroys a large quantity of vegetables of Country A. However, the total revenue from
the sale of vegetables increases. With the aid of a diagram, explain this phenomenon in terms of the price
elasticity of demand. (7 marks)

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2003_Q.9a

Deflation has occurred in Hong Kong since 1998. Government official has said, ‘Deflation in Hong Kong
would stimulate its exports.’ With the aid of a diagram, explain under what condition would deflation
increase Hong Kong’s total export value (in terms of the Hong Kong dollar. (7 marks)

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2009_Q.9b

The price of paper has increased sharply in recent years. With the aid of a diagram, explain under what
condition publishers’ total revenue from the sale of textbooks would increase. (8 marks)

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 6. Types of questions

Demand ↑ P↑ Q↑ TR↑
Type 1 Change in Demand
Demand ↓ P↓ Q↓ TR↓

If demand is elastic TR↑

S↑ P↑ Q↓
Change in Supply
If demand is inelastic TR↓
(or simply rising or
Type 2
lowering the price by
If demand is inelastic TR↑
sellers)
S↓ P↓ Q↑
If demand is elastic TR↓

D↑ P↑ Q↑ D↑ > S↑ P↑

S↑ P↓ Q↑ D↑ < S↑ P↓
Type 3 Change in D and S
D↓ P↓ Q↓ D↓ > S↓ P↓

S↓ P↑ Q↓ D↓ < S↓ P↑

Excess demand Price is below the

(Shortage) equilibrium price.
Product market
Excess supply Price is above the
(Surplus) equilibrium price.
Type 4 Disequilibrium
Excess demand Wage rate is below
(Labour shortage) equilibrium level.
Labour market
Excess supply Wage rate is above
(Labour surplus) equilibrium level.

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