Study notes

Explaining Price Elasticity of Demand

Price elasticity of demand measures the responsiveness of demand after a change in a product's own price.

This is perhaps the most important microeconomic concept that you will come across in your initial studies of economics. The key is to understand the formula for calculating price elasticity, the factors that affect elasticity and then why elasticity matters for businesses when setting their prices.

Explaining Price Elasticity of Demand (Topic Video)
Explaining Price Elasticity of Demand (Topic Video)

What is the formula for calculating the coefficient of price elasticity of demand?

The formula for calculating the co-efficient of elasticity of demand is:

Percentage change in quantity demanded divided by the percentage change in price

Since changes in price and quantity usually move in opposite directions, usually we do not bother to put in the minus sign. We are more concerned with the co-efficient of elasticity of demand rather than the sign!
Numerical examples of price elasticity of demand

How much does quantity demanded change when price changes? By a lot or by a little? Elasticity can help us understand this important question.

What are the important values for price elasticity of demand?

We use the word "coefficient" to describe the values for price elasticity of demand

  1. If Ped = 0 demand is perfectly inelastic - demand does not change at all when the price changes – the demand curve will be vertical.
  2. If Ped is between 0 and 1 (i.e. the % change in demand from A to B is smaller than the percentage change in price), then demand is inelastic.
  3. If Ped = 1 (i.e. the % change in demand is exactly the same as the % change in price), then demand is unit elastic. A 15% rise in price would lead to a 15% contraction in demand leaving total spending the same at each price level.
  4. If Ped > 1, then demand responds more than proportionately to a change in price i.e. demand is elastic. For example if a 10% increase in the price of a good leads to a 30% drop in demand. The price elasticity of demand for this price change is –3

Inelastic demand (Ped <1)

Inelastic demand

Elastic demand (Ped >1)

Price elastic demand

Perfectly inelastic demand (Ped = zero)

Zero price elasticity

Perfectly elastic demand

Perfectly elastic demand

Unitary price elasticity of demand

Unitary price elasticity

Evaluation

Cool student video on elasticity of demand
Cool student video on elasticity of demand
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Economics