Documented Problem Solving: Price Elasticity of Demand
- describe the relationship between the price of a good and the demand for the good;
- interpret the impact a change in price will have on demand based on the price elasticity;
- compare the impact that a change in price will have on total revenue based on elasticity.
Context for Use
Description and Teaching Materials
For this exercise, the instructor will need a MC, T/F, or short answer question that involves critical thinking. One is given below.
If the price elasticity of demand for a product is equal to 1, then a decrease in price will cause:
a) An increase in total revenue.
b) A decrease in total revenue.
c) No change in total revenue.
d) An increase in total revenue if the cost is low and a decrease in total revenue if the price is high.
Teaching Notes and Tips
Students sometimes struggle with the concept of price elasticity of demand, but if they focus on the idea that elasticity measures how much something will stretch or change, it will be easier for them. If demand for a product is elastic, meaning it changes, then a change in price will cause an even bigger change in demand. The opposite is also true.
Below is a sample of a student solution that includes the thought processes used to solve the question.
- First, I thought about the definition for price elasticity of demand. It measures how much demand will change in response to a change in price.
- This reminded me of the law of demand - the quantity demanded of a good increases as the price of the good decreases.
- I looked back in my notes for the formula for elasticity. It is the (percentage change in quantity demanded) ÷ (percentage change in price).
- Based on the formula in order for elasticity to equal 1, the percentage change in quantity demanded must be the same as the percentage change in price.
- I looked in the textbook for the formula for total revenue. It is equal to price X quantity.
- Then I looked for the relationship between elasticity and a change in total revenue.
- If elasticity is 1, that means that the numerator and the denominator are the same, so the percentage change in quantity demanded is equal to the percentage change in price.
- If the percentage change on the bottom (quantity demanded) is equal to the percentage change on the top (price), then a price decrease will cause an increase in quantity demanded.
- I know that total revenue is price X quantity, so if both change by the same percentage, then total revenue stays the same.
References and Resources
Angelo, T.A. and Cross, K.P. (1993). Classroom Assessment Techniques: A Handbook for College Teachers. San Francisco: Jossey-Bass.