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 (ceteris paribus, i.e. 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, have a positive PED. In general, the demand for a good is said to be inelastic (or relatively inelastic) when the PED is less than one (in absolute value): that is, changes in price have a relatively small effect on the quantity of the good demanded.

Definition
It is a measure of responsiveness of the quantity of a good or service demanded to changes in its price. [1] The formula for the coefficient of price elasticity of demand for a good is:

Two alternative elasticity measures avoid or minimise these shortcomings of the basic elasticity formula: point-price

elasticity and arc elasticity.

Point-price elasticity
One way to avoid the accuracy problem described above is to minimise the difference between the starting and ending prices and quantities. This is the approach taken in the definition of point-price elasticity, which uses differential calculus to calculate the elasticity for an infinitesimal change in price and quantity at any given point on the demand curve: [14]

Arc elasticity
A second solution to the asymmetry problem of having a PED dependent on which of the two given points on a demand curve is chosen as the "original" point and which as the "new" one is to compute the percentage change in P and Q relative to the average of the two prices and the average of the two quantities, rather than just the change relative to one point or the other.

This method for computing the price elasticity is also known as the "midpoints formula", because the average price and average quantity are the coordinates of the midpoint of the straight line between the two given points

Determinants
The overriding factor in determining PED is the willingness and ability of consumers after a price change to postpone immediate consumption decisions concerning the good and to search for substitutes ("wait and look"). [24] A number of factors can thus affect the elasticity of demand for a good:[25]

Availability of substitute goods Breadth of definition of a good: Percentage of income: Duration: Brand loyalty: Who pays:

Interpreting values of price elasticity coefficients

Perfectly inelastic demand[10]

Perfectly elastic demand[10]

Elasticities of demand are interpreted as follows:[10]

Value

Descriptive Terms

Perfectly inelastic demand

Inelastic or relatively inelastic demand

Unit elastic, unit elasticity, unitary elasticity, or unitarily elastic demand

Elastic or relatively elastic demand

Perfectly elastic demand

The concept of elasticity is simply the slope relationship of two variables expressed in percentage terms. Price elasticity is an important determinant of the price firms will charge for their product. When demand is price elastic, lowering price will increase total revenue; and when demand is inelastic, lowering price will decrease total revenue. Price elasticity of demand is calculated as the ratio of the relative change in quantity demanded to the relative change in price. Mathematically, price elasticity of demand is just the percent change in quantity demanded divided by the percent change in price. In this way, price elasticity of demand answers the question "what would be the percent change in quantity demanded in response to a 1 percent increase in price?" Notice that, because price and quantity demanded tend to move in opposite directions, price

elasticity of demand usually ends up being a negative number. To make things simpler, economists will often represent price elasticity of demand as an absolute value. (In other words, price elasticity of demand could just be represented by the positive part of the elasticity number, eg. 3 rather than -3.) Conceptually, you can think of elasticity as an economic analogue to the literal concept of elasticity- in this analogy, the change in price is the force applied to a rubber band, and the change in quantity demanded is how much the rubber band stretches. If the rubber band is very elastic, the rubber band will stretch a lot, and it it's very inelastic, it won't stretch very much, and the same can be said for elastic and inelastic demand. The Slope of the Demand Curve The demand curve is drawn with price on the vertical axis and quantity demanded (either by an individual or by an entire market) on the horizontal axis. Mathematically, the slope of a curve is represented by rise over run, or the change in the variable on the vertical axis divided by the change in the variable on the horizontal axis. Therefore, the slope of the demand curve represents change in price divided by change in quantity, and it can be thought of as answering the question "by how much does an item's price need to change for customers to demand one more unit of it?" Elasticity, on the other hand, aims to quantify the responsiveness of demand and supply to changes in price, income, or other determinants of demand. Therefore, price elasticity of demand answers the question "by how much does the quantity demanded of an item change in response to a change in price?" The calculation for this requires changes in quantity to be divided by changes in price rather than the other way around. Price Elasticity of Supply and the Slope of the Supply Curve Using similar logic, the price elasticity of supply is equal to the reciprocal of the slope of the supply curve times the ratio of price to quantity supplied. In this case, however, there is no complication regarding arithmetic sign, since both the slope of the supply curve and the price elasticity of supply are greater than or equal to zero. Other elasticities, such as the income elasticity of demand, don't have straightforward relationships with the slopes of the supply and demand curves. If one were to graph the relationship between price and income (with price on the vertical axis and income on the horizontal axis), however, an analogous relationship would exist between the income elasticity of demand and the slope of that graph.