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Demand Curves with Constant Elasticity
While the elasticity on straight line demand curves is always changing, it is possible to construct demand curves where elasticity remains constant along the curve. This graph presents three constant elasticity demand curves with demand elasticities of -.5, -1.0 and -2.0 respectively.
Here are two problems to think about:
Problem 1: For each of the demand curves, what should happen to total revenue when the price is reduced?†
Problem 2: Consider the following statement. A particular supplier faces a demand curve with constant elasticity of -2.0. With this elasticity, every 1 percent cut in price will raise quantity by 2 percent and so total revenue will increase. It follows that the supplierís best strategy is to cut the price as low as possible.
Assuming the supplier really does face a demand curve with constant elasticity of -2.0, explain what is wrong with the statementís logic.