This post will clarify how changes in price can differently impact consumer surplus depending on whether demand is elastic or inelastic.
What is Consumer Surplus?
Consumer surplus is the difference between what consumers are willing to pay for a good or service and what they actually pay. It represents the benefit consumers receive from purchasing a product at a lower price than their maximum willingness to pay.
What is Price Elasticity of Demand?
Price elasticity of demand measures how responsive the quantity demanded of a good is to a change in its price.
Elastic demand: When a small percentage change in price leads to a larger percentage change in quantity demanded.
Inelastic demand: When a large percentage change in price leads to a smaller percentage change in quantity demanded.
How Does PED Affect Consumer Surplus?
Absolute Terms: This refers to the actual amount of change in consumer surplus. Referring to the diagram, the consumer surplus decreases by RM57.5 in inelastic case, that is the absolute change. When demand is price inelastic, an increase in price results in a smaller decrease in quantity demanded. Consumers are less sensitive to price changes and continue buying almost the same quantity. Therefore, the loss in consumer surplus is greater in absolute terms because the remaining consumers pay much higher prices.
If the price increases by the same amount, an inelastic PED would result in a greater loss in CS in absolute terms.
Similarly, if a tax increases by the same amount, an inelastic PED would also cause a greater loss in CS.
Relative Terms: This refers to the change in consumer surplus as a percentage of the original consumer surplus. For instance, if the original consumer surplus was RM200 and it decreases by RM100, the relative change would be 50% (since RM100 is 50% of RM200). When demand is price elastic, an increase in price leads to a substantial decrease in quantity demanded. Consumers are highly sensitive to price changes and significantly reduce their purchases. Therefore, the loss in consumer surplus is greater in relative terms because a large portion of the consumer surplus is wiped out quickly. For example, the loss of CS might be 80% of the original CS in the elastic case, but only 10% in the inelastic case.
To summarize:
Absolute terms: The reduction in CS is greater when demand is price inelastic.
Relative terms: The reduction in CS is greater when demand is price elastic.
I hope this clarifies the distinction and helps in understanding the different perspectives on consumer surplus changes.
Feel free to leave your comments or questions below. Happy learning!
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