Question

Variations in the value of the price elasticity of demand are important for how much and at what price a company wants to operate. Based on your understanding on the concept of price elasticity, throughly discuss:

1. Why the price elasticity varies along the demand curve using the example of a linear demand curve;

2. Why a company has to be careful where it operates along its demand curve if it pursues the goal of increasing sales.

Answer 1

The price elasticity of demand is computed using the the formula-

Question 1) The elasticity demand varies along the demand curve is explained below using the linear demand curve -

Let linear demand function Q = 10 - P. The possible points are - A(10,0); B(8,2); C(5,5); D(2,8); E (0,10). On the x-axis, quantity is plotted and y-axis, price is plotted shown below in the diagram -

The elasticity between A and B is -  

The elasticity between B and C is -

The elasticity between C and D is -   

The elasticity between D and E is -

It is clearly seen that the elasticity varies along the demand curve although the linear demand curve slope is the same and elasticity of demand in terms of the slope is -

But the ratio of price to quantity is changing along the demand curve and so is elasticity of demand.

Question 2. It is important for a firm to keep in mind the elasticity of demand when operating on the demand curve. Because for the same price change the change in quantity will be different depending on the elasticity. As more elastic demand elasticity implies even a 1% change in price large percentage change in quantity demanded in comparison to the more inelastic demand. And so is the quantity sold by the firm will be different. Therefore, necessary is not to ignore where the firm is operating on the demand.