Price Elasticity of Demand

Price Elasticity of Demand (PED) is defined as the responsiveness of quantity demanded to a change in price. It is also the slope of the demand curve. We calculate the slope as “rise over run.”

For example, if I increase the price of a phone from $300 to $500, then how much can I expect my demand to fall? This answer will depend on various factors mentioned below that will help the firm calculate its Price Elasticity of Demand.

Factors Affecting Price Elasticity of Demand

Factors Affecting the Price Elasticity of Demand

Price Elasticity of Demand helps producers determine their change in Total Revenue if they have to change the price of the product (Quantity of goods they sell x the Price its sold at). The change in total revenue depends on the elasticity.

1. Substitutes

If there is a greater availability of substitutes, then the good is likely to be more elastic. For example, if the price of one soda brand goes up, people can turn to other brands. So, a small change in price is likely to cause a greater fall in quantity demanded.

2. Necessities

If a good is a necessity, then the demand tends to be inelastic. For example, if the price for drinking water rises, then there is unlikely to be a huge drop in the quantity demanded since drinking water is a necessity.

3. Time

Over time, a good tends to become more elastic. For example, if the price of gasoline goes up, over time people will adjust for the change, i.e., they may drive less or use public transportation or form carpools.

4. Habit

The demand for addictive or habitual products is usually inelastic. For example, if the price for a pack of cigarettes goes up, it will likely not have any effect on demand.

Uses of Price Elasticity of Demand

  • Allows a firm to predict the change in revenue with the change in price.
  • Firms can charge different prices in different markets if elasticities differ in income groups. This practice is known as price discrimination.
  • Allows a firm to decide how much tax to pass on to a consumer.
  • Enables the government to predict the impact of taxation policies on products.

Price Elasticity of Demand Formula

If you’re looking for how to calculate price elasticity of demand, simply follow this formula.

price elasticity of demand formula

%∆ in Qd = Percentage Change in Quantity Demanded. The Percentage Change in Quantity Demanded is the New Quantity Demanded minus the Old Quantity Demanded divided by the Old Quantity Demanded.

%∆ in P = Percentage Change in Price. This is the New Price minus the Old Price divided by the Old Price.

PED = %∆ in Qd / %∆ in P

The value of Price Elasticity of Demand (PED) is always negative. This is because the ratio of changes of the two variables is in opposite directions, so if the price goes up, demand goes down and the change will end up negative.

Price Elasticity of Demand Examples

For our examples of price elasticity of demand, we will use the price elasticity of demand formula.

1. Widget Inc. decides to reduce the price of its product, Widget 1.0  from $100 to $75. The company predicts that the sales of Widget 1.0 will increase from 10,000 units a month to 20,000 units a month.

To calculate the price elasticity of demand, first, we will need to calculate the percentage change in quantity demanded and percentage change in price.

% Change in Price = ($75-$100)/($100)= -25%

% Change in Demand = (20,000-10,000)/(10,000) = +100%

Therefore, the Price Elasticity of Demand = 100%/-25% = -4.

This means the demand is relatively elastic.

Price Elasticity of Demand on a Demand Curve

We can represent all the different values of price elasticity of demand on a demand curve as seen below.

Price Elasticity of Demand
PED Along a Demand Curve

Range of Price Elasticity of Demand

1. Perfectly Inelastic Demand, (PED = 0)

The quantity demanded doesn’t change at all with price.

Perfectly Inelastic Demand

Price ↑ → Total Revenue ↑

Price ↓ → Total Revenue ↓

2. Relatively Inelastic Demand, (PED = 0 < x < 1)

The quantity demanded changes by a smaller percentage than the change in price.

Relatively Inelastic Demand

Price ↑ → Total Revenue ↑

Price ↓ → Total Revenue ↓

3. Unit Elastic Demand, (PED = 1)

The quantity demanded changes by the same percentage as the change in price.

Unit Elastic Demand

Price ↑ → No Change in Total Revenue

Price ↓ → No Change in Total Revenue

4. Relatively Elastic Demand, (PED = 1 < x < ∞)

The quantity demanded changes by a larger percentage than the change in price.

Relatively Elastic Demand

Price ↑ → Total Revenue ↓

Price ↓ → Total Revenue ↑

5. Perfectly Elastic Demand, (PED = ∞)

Consumers will buy all available at some price, but none at any other price.

Perfectly Elastic Demand

Price ↑ → 0 Total Revenue

Price ↓ → 0 Total Revenue

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