Skip to content

M05.L04 — Elasticity Along the Demand Curve and Revenue Effects

Module: Module 05 — Economic Surplus and Elasticity Lesson: L04 of 06 Duration: ~30 minutes Level: Introductory Provenance: Microeconomics 1e (Medeiros) | OpenStax Principles of Microeconomics 3e

Learning Objective

Explain how elasticity varies along a linear demand curve and its impact on total revenue.

Elasticity Along the Demand Curve

For a linear demand curve: - Top: Elastic (PED >1), where small price changes cause large quantity changes. - Midpoint: Unit elastic (PED =1), where total revenue (TR = P × Q) is maximised. - Bottom: Inelastic (PED <1), where price changes have minimal effect on quantity.

Australian example: Electricity demand is inelastic at low prices but becomes elastic as prices rise.

Worked Example

Revenue Effects for Sydney Coffee Shops

  1. Demand Curve: \( P = 10 - Q \).
  2. Midpoint: At P=$5, Q=5 (unit elastic).
  3. TR Test:
  4. Price ↑ $6 → Q=4: TR = $24 (was \(25 at P=\)5).
  5. Price ↓ $4 → Q=6: TR = $24 (again, less than $25).

Common Misconception

"Lowering prices always increases revenue."

Only true in elastic regions; in inelastic regions, price cuts reduce revenue.

Key Takeaways

  • Elasticity varies along linear demand curves.
  • TR is maximised at unit elasticity.
  • The "total revenue test" predicts TR changes from price moves.
  • Australian firms use this for pricing (e.g., airlines, utilities).

Practice

  1. If PED = 1.5 and price rises 10%, what happens to TR?
  2. Draw a demand curve with P=20 at Q=0 and P=0 at Q=20. Identify elastic, unit, and inelastic regions.
  3. Why do Australian cinemas charge differently for peak vs. off-peak tickets?

Further Resources

Provenance: Microeconomics 1e (Medeiros) | OpenStax Principles of Microeconomics 3e