Elasticity of Demand and Supply
Domain 3 tests price, income, and cross elasticity, the total-revenue test, and elasticity of supply. You must distinguish point and arc elasticity and interpret coefficients correctly.
Core rules and concepts
- Price elasticity Ed = percentage change in quantity demanded ÷ percentage change in price; ignore the negative sign when using the absolute value.
- Ed > 1 is elastic, Ed < 1 inelastic, Ed = 1 unitary; perfectly elastic is horizontal, perfectly inelastic vertical.
- If demand is elastic, a price cut raises total revenue; if inelastic, a price cut lowers it; if unitary, revenue is unchanged.
- Income elasticity is positive for normal goods, negative for inferior goods; cross elasticity is positive for substitutes, negative for complements.
- Supply elasticity depends on time, spare capacity, and factor mobility.
Worked example
Price falls from ₹10 to ₹8, a 20% fall, and quantity rises from 10 to 14, a 40% rise. Ed = 40 ÷ 20 = 2, so demand is elastic. Total revenue rises from ₹100 to ₹112, confirming that a price cut pays when demand is elastic. For a large change, the midpoint formula gives the same conclusion without choosing an arbitrary base: change in Q = 4, average Q = 12, change in P = ₹2, average P = ₹9, so Ed = (4/12) ÷ (2/9) = 1.5.
Traps that cost marks
Do not confuse elasticity with slope; a steep curve can still be elastic at high prices. Do not use the revenue test backwards. Do not drop the sign when classifying complements and substitutes. Do not use initial values only for large changes; use the midpoint formula when asked.