A pharmaceutical company sells insulin, for which demand is highly inelastic. If they raise the price by 20%, what happens to total revenue?
ATotal revenue falls — the higher price drives away enough customers to reduce overall revenue
BTotal revenue rises — inelastic buyers largely continue purchasing, so the price increase outweighs the small quantity decrease
CTotal revenue is unchanged — for inelastic goods, price changes never affect revenue
DTotal revenue may rise or fall depending on the slope of the demand curve at the current price
This is the total revenue test: for inelastic demand (|PED| < 1), price and total revenue move in the same direction. Because buyers are relatively unresponsive to price changes, a price increase causes only a small drop in quantity demanded — not enough to offset the higher revenue per unit. Total revenue rises. Option A describes what happens with elastic demand. Option C is wrong — inelastic demand does not mean revenue is fixed. Option D confuses slope with elasticity; for a given price point, it is elasticity (not slope) that determines the revenue effect.
Question 2 Multiple Choice
As you move from the top of a linear demand curve (high price, low quantity) down to the bottom (low price, high quantity), how does price elasticity of demand change?
AIt remains constant — a linear curve has constant slope, so elasticity is also constant
BIt increases — lower prices make consumers more sensitive to further price changes
CIt decreases — demand becomes more inelastic as you move toward lower prices and higher quantities
DIt first increases then decreases, reaching a maximum at the midpoint
Along a linear demand curve, elasticity decreases as you move from top to bottom (from the high-price, low-quantity end to the low-price, high-quantity end). At the top, a given absolute price change is a small percentage of a large price, while the resulting quantity change is a large percentage of a small quantity — demand is elastic. At the bottom, the same absolute change is a large percentage of a small price, while the quantity change is a small percentage of a large quantity — demand is inelastic. The midpoint has unit elasticity. Slope is constant; elasticity is not. Option A is the most common misconception.
Question 3 True / False
A steeper demand curve has higher price elasticity of demand than a flatter demand curve at the same price point.
TTrue
FFalse
Answer: False
This is the most persistent misconception in elasticity. A steeper demand curve has LOWER elasticity (more inelastic) than a flatter one at the same price. Slope is ΔQ/ΔP — a ratio of absolute changes. Elasticity is (ΔQ/Q)/(ΔP/P) — a ratio of percentage changes. Steeper slope means less quantity response per unit of price change, which translates to a smaller |PED|. A perfectly vertical demand curve has zero elasticity (perfectly inelastic); a perfectly horizontal curve has infinite elasticity (perfectly elastic). Slope and elasticity move in opposite directions.
Question 4 True / False
Price elasticity of demand changes at every point along a linear demand curve, even though the slope is constant throughout.
TTrue
FFalse
Answer: True
This is the key insight that distinguishes elasticity from slope. Slope = ΔQ/ΔP is constant along a linear curve by definition. But elasticity = (ΔQ/Q)/(ΔP/P) = (ΔQ/ΔP) × (P/Q). Since P and Q change as you move along the curve, the ratio P/Q changes continuously — and therefore so does elasticity, even though ΔQ/ΔP is fixed. At the top of the curve, P is large and Q is small, so P/Q is large and elasticity is high. At the bottom, P is small and Q is large, so elasticity is low. The midpoint of the curve has unit elasticity.
Question 5 Short Answer
Why can't we describe a linear downward-sloping demand curve as simply 'elastic' or 'inelastic,' and what does this imply for how firms should interpret demand data?
Think about your answer, then reveal below.
Model answer: Because elasticity changes at every point along the curve. At high prices (top of the curve), demand is elastic — a small percentage price decrease brings a large percentage increase in quantity. At low prices (bottom), demand is inelastic — the same price change has a smaller proportional quantity effect. Only at the midpoint is elasticity exactly 1. A firm cannot say 'our demand is inelastic' as a blanket statement; it can only say 'demand is inelastic at prices below X.' This matters for pricing: raising price increases revenue when demand is inelastic at that price point, but decreases revenue when demand is elastic — the same product, different conclusions at different prices.
The practical implication is that firms must estimate elasticity at the specific price point under consideration, not assume it is constant. This is why economists use the midpoint formula for arc elasticity between two specific prices, rather than treating the entire demand curve as uniformly elastic or inelastic. Revenue-maximizing pricing requires finding the price where elasticity equals 1 (unit elastic), which is the peak of the total revenue curve.