Elasticity and Consumer Behavior
Core concepts
Price elasticity of demand measures responsiveness: percentage change in quantity divided by percentage change in price. Use the midpoint formula to avoid direction bias. Demand is elastic when the absolute value exceeds 1, inelastic when below 1, and unit elastic at 1. Total revenue rises with a price cut when demand is elastic and falls when demand is inelastic. Determinants include availability of substitutes, share of budget, time horizon, and necessity versus luxury. Income elasticity is positive for normal goods and negative for inferior goods. Cross-price elasticity is positive for substitutes and negative for complements. Price elasticity of supply rises with time as producers adjust. Consumer behavior uses utility: total utility rises while marginal utility generally diminishes, and consumers maximize satisfaction when marginal utility per dollar is equal across goods.
Traps to watch
- Forgetting absolute value when classifying elasticity.
- Assuming a steep curve is always inelastic regardless of axis scaling.
- Computing percentage changes with the simple method when the question expects midpoint.
- Confusing income and cross-price elasticity signs.
Worked example
Price falls from $10 to $8; quantity rises from 50 to 70. Midpoint change in quantity is 20/60 = 33.3%, price change is 2/9 = 22.2%, so elasticity is about 1.5 - elastic, and total revenue rises from $500 to $560.