Tags: demand curve, demand shifters, price elasticity of demand, elastic, inelastic, unit elastic, vertical demand curve, income effect, substitutes, complements, elasticity calculation, percentage change method, ECON 323, Texas A&M, microeconomics
Demand analysis focuses on what determines the quantity consumers want to buy and how responsive that quantity is to price changes. Elasticity is the core measurement tool. Understanding what shifts the demand curve versus what causes a movement along it is fundamental, and elasticity calculations appear in both short answer and long answer questions.
Demand curve
A graph showing the relationship between the price of a good and the quantity demanded, holding all other factors constant. Downward-sloping by the law of demand.
Movement along the demand curve
Caused by a change in the price of the good itself. The curve does not shift; the consumer moves to a different point on the same curve.
Shift of the demand curve
Caused by a change in a factor other than the good's own price. Shifters include consumer income, prices of related goods (substitutes and complements), tastes, expectations, and number of buyers.
Price elasticity of demand (PED)
A measure of how responsive quantity demanded is to a change in price. Calculated as the absolute value of the percentage change in quantity demanded divided by the percentage change in price.
Elastic demand
|PED| > 1. Quantity demanded is highly responsive to price changes. A price increase leads to a proportionally larger decrease in quantity demanded.
Inelastic demand
|PED| < 1. Quantity demanded is relatively unresponsive to price changes.
Unit elastic demand
|PED| = 1. The percentage change in quantity demanded exactly equals the percentage change in price.
Perfectly inelastic demand (vertical demand curve)
|PED| = 0. Quantity demanded does not respond to price changes at all. The demand curve is a vertical line.
Perfectly elastic demand (horizontal demand curve)
|PED| = ∞. Any price increase above the market level drives quantity demanded to zero. This is the demand curve facing an individual firm in perfect competition.
A change in the good's own price causes a movement along the demand curve, not a shift. The demand curve itself shifts when a non-price determinant changes:
Income: for normal goods, higher income shifts demand right; for inferior goods, higher income shifts demand left
Prices of related goods: a rise in the price of a substitute shifts demand right; a rise in the price of a complement shifts demand left
Tastes and preferences: a favourable change shifts demand right
Expectations: if consumers expect higher future prices, current demand shifts right
Number of buyers: more buyers shifts demand right
A change in production technology shifts the supply curve, not the demand curve.
The basic formula (point method, using initial values as base):
PED = |(%ΔQ) / (%ΔP)|
Where:
%ΔQ = (Q_new - Q_old) / Q_old × 100
%ΔP = (P_new - P_old) / P_old × 100
Worked example:
Price rises from $5 to $8. Quantity falls from 100 to 80.
%ΔP = (8 - 5) / 5 = 60%
%ΔQ = (80 - 100) / 100 = -20%
PED = |-20% / 60%| = 0.33
Since 0.33 < 1, demand is inelastic. A 60% price increase caused only a 20% quantity decrease, so consumers are relatively unresponsive to price in this range.
| Value of |PED| | Classification | Meaning | |---|---|---| | 0 | Perfectly inelastic | Quantity does not change (vertical curve) | | Between 0 and 1 | Inelastic | Quantity changes less than proportionally | | 1 | Unit elastic | Quantity changes exactly proportionally | | Greater than 1 | Elastic | Quantity changes more than proportionally | | ∞ | Perfectly elastic | Any price change eliminates all demand (horizontal curve) |
Elasticity connects directly to the rule-of-thumb pricing formula: P = MC / [1 - (1/|E|)].
When demand is more elastic, the optimal markup over MC is smaller (consumers are price-sensitive)
When demand is more inelastic, the firm can charge a larger markup
At |E| = 1, the formula is undefined, meaning a profit-maximising firm should never operate at unit elasticity (it can always increase revenue by raising price into the inelastic region or adjusting output)
Concept | Formula |
|---|---|
PED (point method) | |(%ΔQ) / (%ΔP)| |
%ΔQ | (Q_new - Q_old) / Q_old × 100 |
%ΔP | (P_new - P_old) / P_old × 100 |
Markup pricing | P = MC / [1 - (1/|E|)] |
⚠️ A change in the price of the good itself does not shift the demand curve. It causes a movement along it. This is the single most common mistake in demand analysis.
⚠️ Technology changes shift the supply curve, not the demand curve. If a question offers "technology" as a demand shifter, it is a distractor.
⚠️ A vertical demand curve means completely inelastic (PED = 0), not infinitely elastic. A horizontal curve is infinitely elastic. Mixing these up is easy under time pressure.
⚠️ When calculating elasticity, use the correct base (initial price and quantity for the point method, or the midpoint for the arc method). Read the question to see which method is expected.
⚠️ Know how to classify: |PED| < 1 is inelastic, |PED| > 1 is elastic, |PED| = 1 is unit elastic. The exam will ask you to calculate and classify.
Q: Which of the following shifts the demand curve: a change in the good's own price, a change in consumer income, or a change in production technology?
A: A change in consumer income. A change in the good's own price is a movement along the curve; a change in technology shifts the supply curve, not the demand curve.
Q: Price rises from $5 to $8 and quantity falls from 100 to 80. What is the PED, and is demand elastic or inelastic?
A: %ΔP = 60%, %ΔQ = -20%. PED = |-20%/60%| = 0.33. Since 0.33 < 1, demand is inelastic.
Q: What does a vertical demand curve imply about elasticity?
A: Completely inelastic demand (PED = 0). Quantity demanded does not change regardless of price.
Q: A firm faces |E| = 3 and MC = $20. What is the profit-maximising price?
A: P = 20 / [1 - (1/3)] = 20 / (2/3) = $30.
Q: Why should a profit-maximising firm never produce at the unit-elastic point on its demand curve?
A: At unit elasticity, marginal revenue is zero. The firm could increase total revenue (and profit, assuming MC > 0) by adjusting output away from that point.
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