Economics – The allocation of resources - Price elasticity of supply (PES) | e-Consult

Elastic demand means that the percentage change in quantity demanded is greater than the percentage change in price. The PED value is less than -1. Consumers are very responsive to price changes. Inelastic demand means that the percentage change in quantity demanded is less than the percentage change in price. The PED value is greater than -1. Consumers are not very responsive to price changes.

Firm's Response to Changes in Demand Elasticity:

• Elastic Demand: If demand is elastic, a firm might lower its price to increase total revenue. The increase in quantity demanded will be more than proportional to the price decrease.

• Inelastic Demand: If demand is inelastic, a firm might raise its price to increase total revenue. The decrease in quantity demanded will be less than proportional to the price increase.

• Examples:

  • Elastic Demand Example: Consider a luxury car manufacturer. If the price of a luxury car increases, demand will likely fall significantly, as consumers can easily switch to a cheaper alternative. The firm might lower prices to boost sales.

  • Inelastic Demand Example: Consider a life-saving drug. Even if the price increases, demand will remain relatively constant because people need the drug. The firm might raise prices to increase total revenue.

Impact on Total Revenue:

• Elastic Demand: A price increase will lead to a decrease in total revenue. A price decrease will lead to an increase in total revenue.

• Inelastic Demand: A price increase will lead to an increase in total revenue. A price decrease will lead to a decrease in total revenue.

Therefore, understanding the elasticity of demand is crucial for firms to make informed pricing decisions that maximize their profitability. Firms must analyze consumer responsiveness to price changes and adjust their strategies accordingly.