Price elasticity of demand
Price elasticity of demand (PED or Ed) is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. More precisely, it gives the percentage change in quantity demanded in response to a one percent change in price (holding constant all the other determinants of demand, such as income). It was devised by Alfred Marshall.
@Price elasticities are almost always negative, although analysts tend to ignore the sign even though this can lead to ambiguity. Only goods which do not conform to the law of demand, such as Veblen and Giffen goods, have a positive PED.
A. Percentage Change in Price
1. The midpoint method uses the average of the initial price and new price in the denominator when calculating a percentage change. Because the average price is the same between two prices regardless of whether the price falls or rises, the percentage change in price calculated by the midpoint method is the same for a price rise and a price fall.
a. Using the midpoint formula, the percentage change in price equals
Price elasticity of demand is calculated by dividing the proportionate change in quantity demanded by the proportionate change in price.
PRICE ELASITY OF DEMAND= %CHANGE IN QUANTITY DEMANED
----------------------------------------------
% CHANGE IN PRICE
= Q2 - Q1
---------
( Q1 + Q2 ) / 2
-----------------------------------------------
P2 - P1
----------
( P1 + P2 ) / 2
where
Q1 = Initial quantity
Q2 = Final quantity
P1 = Initial price
P2 = Final price
Minus Sign-Because a change in price causes an opposite change in quantity demanded, for the price elasticity of demand we focus on the magnitude of the change by using the absolute value
The price elasticity of demand falls into three categories:
1. Elastic demand—when the percentage change in the quantity demanded exceeds the percentage change in price (which means the elasticity is greater than 1).
We typically look at goods that have elastic demand or supply curves as ones with many substitutes. Typically, we see Coca Cola and Pepsi as substitutes**. For example, if the price of Pepsi were to increase, people are more likely to purchase Coca Cola. We can say that consumers are basically indifferent between the two products; this makes consumers sensitive to the price.
2. Unit elastic demand—when the percentage change in the quantity demanded equals the percentage change in price (which means the elasticity equals 1).
3. Inelastic demand—when the percentage change in the quantity demanded is less than the percentage change in price (which means the elasticity is less than 1).
Oil is an example of an inelastic good in the United States. Americans depend on their cars to get to work. Further, the majority of Americans do not have access to commute alternatives such as electric rail (few substitutes for oil). Therefore, if the price of oil increases, the demand for gasoline will not be impacted much. This is particularly true in the short run.
4. There are two extreme cases:
a. Perfectly elastic demand—when the quantity demanded changes by a very large percentage in response to an almost zero percentage change in price.
b. Perfectly inelastic demand—when the quantity demanded remains constant as the price changes.
Price elasticity of demand (PED or Ed) is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. More precisely, it gives the percentage change in quantity demanded in response to a one percent change in price (holding constant all the other determinants of demand, such as income). It was devised by Alfred Marshall.
@Price elasticities are almost always negative, although analysts tend to ignore the sign even though this can lead to ambiguity. Only goods which do not conform to the law of demand, such as Veblen and Giffen goods, have a positive PED.
A. Percentage Change in Price
1. The midpoint method uses the average of the initial price and new price in the denominator when calculating a percentage change. Because the average price is the same between two prices regardless of whether the price falls or rises, the percentage change in price calculated by the midpoint method is the same for a price rise and a price fall.
a. Using the midpoint formula, the percentage change in price equals
Price elasticity of demand is calculated by dividing the proportionate change in quantity demanded by the proportionate change in price.
PRICE ELASITY OF DEMAND= %CHANGE IN QUANTITY DEMANED
----------------------------------------------
% CHANGE IN PRICE
= Q2 - Q1
---------
( Q1 + Q2 ) / 2
-----------------------------------------------
P2 - P1
----------
( P1 + P2 ) / 2
where
Q1 = Initial quantity
Q2 = Final quantity
P1 = Initial price
P2 = Final price
Minus Sign-Because a change in price causes an opposite change in quantity demanded, for the price elasticity of demand we focus on the magnitude of the change by using the absolute value
The price elasticity of demand falls into three categories:
1. Elastic demand—when the percentage change in the quantity demanded exceeds the percentage change in price (which means the elasticity is greater than 1).
We typically look at goods that have elastic demand or supply curves as ones with many substitutes. Typically, we see Coca Cola and Pepsi as substitutes**. For example, if the price of Pepsi were to increase, people are more likely to purchase Coca Cola. We can say that consumers are basically indifferent between the two products; this makes consumers sensitive to the price.
2. Unit elastic demand—when the percentage change in the quantity demanded equals the percentage change in price (which means the elasticity equals 1).
3. Inelastic demand—when the percentage change in the quantity demanded is less than the percentage change in price (which means the elasticity is less than 1).
Oil is an example of an inelastic good in the United States. Americans depend on their cars to get to work. Further, the majority of Americans do not have access to commute alternatives such as electric rail (few substitutes for oil). Therefore, if the price of oil increases, the demand for gasoline will not be impacted much. This is particularly true in the short run.
4. There are two extreme cases:
a. Perfectly elastic demand—when the quantity demanded changes by a very large percentage in response to an almost zero percentage change in price.
b. Perfectly inelastic demand—when the quantity demanded remains constant as the price changes.