Price elasticity

In this case, the two key words are 'price' and 'demand', so the price elasticity of
demand measures the responsiveness of the quantity demanded to a given
price change.
Note - Price elasticity of demand is generally known as elasticity of demand .There is
no difference between price elasticity of demand and elasticity of demand. By the
term elasticity of demand, we generally refer to price elasticity of demand;
because, price of a commodity is the most important factor that affects its demand.
The demand elasticity formula calculates the impact of a change in price for a given
product on demand. The law of demand merely explains the qualitative relationship
while the concept of elasticity of demand analyses the quantitative price-demand
relationship.
Price elasticity of demand (e
p
) = Percentage change in quantity demanded /
Percentage change in price
Symbolically,
Ed = %change in quantity demanded
% change in price
PED = (Q/Q)/(P/P) ;
Alternatively PED = (Q/Q) (P/P)
By rearranging PED = (Q/P) (P/Q)

Illustration 1:
The percentage decrease in the price of the commodity is 25% and the percentage
increase in the quantity demanded is 50%.
Hence,
e
p
= 50%/-25% = -2
Note that the price elasticity is always negative because of the inverse relationship
between price and quantity demanded (law of demand). However, as a conventional
way, we ignore the negative sign when calculating the price elasticity.

Illustration 2:
(a) When the price of oranges is $5, the quantity demanded is 20 KGs.
(b) When the price of oranges is $4, the quantity demanded is 24 KGs.
Thus, P = 5, Q = 20; P = 1, Q = 4
e
p
= (Q/P) (P/Q) = (4/1) (5/20) = 1

Note -Instead of the term percentage change, we can use the term proportionate
change also.
Therefore,
e
p
= Proportionate change in quantity demanded / Proportionate change in price

Understanding Elastic and Inelastic
Price Elastic Demand:
Definition: Demand is price elastic if a change in price leads to a bigger % change in
demand; therefore the PED will therefore be greater than 1.

Elastic Demand PED >1 Perfectly Elastic PED =
Goods which are elastic tend to have some or all of the following characteristics.
1. They are luxury goods, e.g. sports cars
2. They are expensive and a big % of income e.g. sports cars and holidays
3. Goods with many substitutes and a very competitive market. E.g. if Sainsburys put
up the price of its bread there are many alternatives, so people would be price
sensitive.
Price Inelastic Demand
These are goods where a change in price leads to a smaller % change in demand;
therefore PED <1, for example PED= 0.5


Inelastic demand PED <1 Perfectly inelastic PED =0

Goods which are inelastic tend to have some or all of the following features:
1. They have few or no close substitutes, e.g. petrol, cigarettes.
2. They are necessities, e.g. if you have a car, you need to keep buying petrol, even if
price of petrol increases
3. They are addictive, e.g. cigarettes.
4. They cost a small % of income or are bought infrequently.

NOTE-In the short term demand is usually more inelastic because it takes time to
find alternatives.
If the price of chocolate increased demand would be inelastic because there are no
alternatives, however if the price of mars increased there are close substitutes in the
form of other chocolate therefore demand will be more elastic.


Degrees / Kinds / Types of price elasticity of demand
The price elasticity of demand can be any value between zero and infinity
If Price Elasticity of Demand = 0, then demand is perfectly inelastic. This
means that demand is not affected by price changes (the demand curve in
this instance is vertical).
If Price Elasticity of Demand = between 0 and 1, then demand is
inelastic. This means that the demand change will be proportionately smaller
than the price change.
If Price Elasticity of Demand = 1, then demand is unit elastic. This means
that the increase in price would result in the same decrease percentage in
demand.
If Price Elasticity of Demand is greater than 1, then demand is elastic
and it is more than proportionately affected by a change in price.

Numerical
Value
Terminology Description
Shape of
the
Demand
Curve
Examples
1. Price
Elasticity =

Perfectly elastic
A consumer
will buy all the
quantity of
the
commodity at
this price and
nothing else
at some other
price.
Horizontal --
2. Price
Elasticity = 0
Perfectly
inelastic
Demand
remains
unchanged
whatever be
the change in
price
Vertical Medicines
3. Price
Elasticity = 1
Unitary elastic
% Q = %
P
Rectangular
hyperbola
--
4. 0 < Price
Elasticity < 1
Inelastic
% Q < %
P
Flatter
Essential
goods
5. > Price
Elasticity > 1
Elastic
% Q > %
P
Steeper
Luxuries
and
comforts

Percentage change in quantity demanded divided by percentage change
in price.
The percentage of change in quantity demanded is: [QDemand(NEW) -
QDemand(OLD)] / QDemand(OLD)
The percentage of change in price is: [Price(NEW) - Price(OLD)] /
Price(OLD)