Definition
Price elasticity of demand (PED) is an economics concept that describes the degree to which the quantity demanded of a good or service changes in response to a change in its price. The formula for calculating price elasticity is:
\[ \text{Price Elasticity of Demand} = \frac{\text{Percentage Change in Quantity Demanded}}{\text{Percentage Change in Price}} \]
There are three main types of price elasticity delineated based on the aforementioned formula:
- Elastic Demand: If the absolute value of the elasticity is greater than 1, a change in price leads to a larger percentage change in quantity demanded.
- Inelastic Demand: If the absolute value of the elasticity is less than 1, a change in price leads to a smaller percentage change in quantity demanded.
- Unitary Elasticity: If the elasticity is exactly 1, a percentage change in price leads to an equal percentage change in quantity demanded.
Examples
- Elastic Demand: Luxury items tend to have elastic demand. For example, if the price of high-end electronics like a new smartphone decreases by 10%, the demand might increase by more than 10%.
- Inelastic Demand: Necessities often exhibit inelastic demand. If the price of insulin (for diabetics) increases by 10%, the quantity demanded might decrease by less than 10% due to its essential nature.
- Unitary Elasticity: Let’s consider movie tickets. If a 5% decrease in price leads to a 5% increase in the number of tickets sold, the demand for movie tickets is unitary elastic.
Frequently Asked Questions
What factors influence price elasticity of demand?
Several factors influence PED, including:
- Availability of substitutes: More substitutes result in more elastic demand.
- Necessity versus luxury: Necessities tend to have inelastic demand, while luxuries have more elastic demand.
- Proportion of income spent on the good: Goods that take up a larger portion of a consumer’s income tend to be more elastic.
- Time period: Demand is generally more elastic over the long term as consumers have more time to adjust.
How does price elasticity affect revenue?
- Elastic Demand: Reducing prices increases total revenue, while increasing prices decreases total revenue.
- Inelastic Demand: Raising prices increases total revenue, while reducing prices decreases total revenue.
- Unitary Elasticity: Changes in price do not affect total revenue.
How is price elasticity measured?
Price elasticity is measured using the following formula:
\[ \text{Price Elasticity of Demand} = \frac{\text{Percentage Change in Quantity Demanded}}{\text{Percentage Change in Price}} \]
What is an example of perfectly inelastic demand?
Educational textbooks might be an example in some cases—if the price goes up, students still need to buy them, and if the price goes down, the same students still buy the same number.
What does a price elasticity value of 2 signify?
A price elasticity of 2 means that a 1% change in price leads to a 2% change in quantity demanded, indicative of elastic demand.
Related Terms
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Income Elasticity of Demand: Measures the sensitivity of quantity demanded to a change in consumer income.
\[ \text{Income Elasticity of Demand} = \frac{\text{Percentage Change in Quantity Demanded}}{\text{Percentage Change in Income}} \]
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Cross Elasticity of Demand: Measures the sensitivity of quantity demanded for one good to a change in price of another good.
\[ \text{Cross Elasticity of Demand} = \frac{\text{Percentage Change in Quantity Demanded of Good A}}{\text{Percentage Change in Price of Good B}} \]
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Supply Elasticity: Reflects the sensitivity of the quantity supplied of a good to a change in its price.
\[ \text{Price Elasticity of Supply} = \frac{\text{Percentage Change in Quantity Supplied}}{\text{Percentage Change in Price}} \]
Online References
- Investopedia - Price Elasticity of Demand
- Wikipedia - Price Elasticity of Demand
- Khan Academy - Elasticity
Suggested Books for Further Studies
- “Microeconomics” by Robert S. Pindyck and Daniel L. Rubinfeld
- “Principles of Economics” by N. Gregory Mankiw
- “Economics” by Paul Samuelson and William D. Nordhaus
- “Elasticity and Revenue” by John Williams
Fundamentals of Price Elasticity: Economics Basics Quiz
Thank you for exploring the concept of price elasticity through our detailed explanation and testing your knowledge with our sample quiz questions. Keep striving for excellence in understanding economic principles!
