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Price elasticity of demand

"Elasticity of demand" redirects here. For income elasticity, see income elasticity of demand. For cross
elasticity, see cross elasticity of demand. For wealth elasticity, see wealth elasticity of demand.

"Price elasticity" redirects here. It is not to be confused with Price elasticity of supply.

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, ceteris paribus. More
precisely, it gives the percentage change in quantity demanded in response to a one percent change in
price (ceteris paribus)

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, such as Veblen and
Giffen goods, 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. The demand for a good is said to be elastic (or
relatively elastic) when its PED is greater than one (in absolute value): that is, changes in price have a
relatively large effect on the quantity of a good demanded.

Revenue is maximized when price is set so that the PED is exactly one. The PED of a good can also be
used to predict the incidence (or "burden") of a tax on that good. Various research methods are used to
determine price elasticity, including test markets, analysis of historical sales data and conjoint analysis.

Definition Edit

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

ep dQQdPP

The above formula usually yields a negative value, due to the inverse nature of the relationship between
price and quantity demanded, as described by the "law of demand". For example, if the price
increases by 5% and quantity demanded decreases by 5%, then the elasticity at the initial price and
quantity = −5%/5% = −1. The only classes of goods which have a PED of greater than 0 are Veblen and
Giffen goods. Although the PED is negative for the vast majority of goods and services, economists
often refer to price elasticity of demand as a positive value (i.e., in absolute value terms).
This measure of elasticity is sometimes referred to as the own-price elasticity of demand for a good, i.e.,
the elasticity of demand with respect to the good's own price, in order to distinguish it from the
elasticity of demand for that good with respect to the change in the price of some other good, i.e., a
complementary or substitute good. The latter type of elasticity measure is called a cross-price
elasticity of demand.

As the difference between the two prices or quantities increases, the accuracy of the PED given by the
formula above decreases for a combination of two reasons. First, the PED for a good is not necessarily
constant; as explained below, PED can vary at different points along the demand curve, due to its
percentage nature. Elasticity is not the same thing as the slope of the demand curve, which is
dependent on the units used for both price and quantity. Second, percentage changes are not
symmetric; instead, the percentage change between any two values depends on which one is chosen as
the starting value and which as the ending value. For example, if quantity demanded increases from 10
units to 15 units, the percentage change is 50%, i.e., (15 − 10) ÷ 10 (converted to a percentage). But if
quantity demanded decreases from 15 units to 10 units, the percentage change is −33.3%, i.e., (10 − 15)
÷ 15.

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

What is 'Price Elasticity Of Demand'

Price elasticity of demand is a measure of the relationship between a change in the quantity demanded
of a particular good and a change in its price. Price elasticity of demand is a term in economics often
used when discussing price sensitivity. The formula for calculating price elasticity of demand is:

Price Elasticity of Demand = % Change in Quantity Demanded / % Change in Price

If a small change in price is accompanied by a large change in quantity demanded, the product is said to
be elastic (or responsive to price changes). Conversely, a product is inelastic if a large change in price is
accompanied by a small amount of change in quantity demanded.

VIDEO
What Is Elasticity?

BREAKING DOWN 'Price Elasticity Of Demand'

Price elasticity of demand measures the responsiveness of demand to changes in price for a particular
good. If the price elasticity of demand is equal to 0, demand is perfectly inelastic (i.e., demand does not
change when price changes). Values between zero and one indicate that demand is inelastic (this occurs
when the percent change in demand is less than the percent change in price). When price elasticity of
demand equals one, demand is unit elastic (the percent change in demand is equal to the percent
change in price). Finally, if the value is greater than one, demand is perfectly elastic (demand is affected
to a greater degree by changes in price).

For example, if the quantity demanded for a good increases 15% in response to a 10% decrease in price,
the price elasticity of demand would be 15% / 10% = 1.5. The degree to which the quantity demanded
for a good changes in response to a change in price can be influenced by a number of factors. Factors
include the number of close substitutes (demand is more elastic if there are close substitutes) and
whether the good is a necessity or luxury (necessities tend to have inelastic demand while luxuries are
more elastic).

Businesses evaluate price elasticity of demand for various products to help predict the impact of a
pricing on product sales. Typically, businesses charge higher prices if demand for the product is price
inelastic.

Calculating a %

Quantity fell by 13 / 100 = – 0.13 (13%)

Therefore PED = 13 / – 10

Therefore PED = -1.3

Therefore Demand is elastic. Elastic demand occurs when % change in Quantity is greater than % change
in price; when PED >1

Not to be confused with Price elasticity of demand.

Price elasticity of supply (PES or Es) is a measure used in economics to show the responsiveness, or
elasticity, of the quantity supplied of a good or service to a change in its price.

The elasticity is represented in numerical form, and is defined as the percentage change in the quantity
supplied divided by the percentage change in price.

When the coefficient is less than one, the supply of the good can be described as inelastic; when the
coefficient is greater than one, the supply can be described as elastic. An elasticity of zero indicates
that quantity supplied does not respond to a price change: it is "fixed" in supply. Such goods often have
no labor component or are not produced, limiting the short run prospects of expansion. If the coefficient
is exactly one, the good is said to be unitary elastic.

The quantity of goods supplied can, in the short term, be different from the amount produced, as
manufacturers will have stocks which they can build up or run down.

Determinants Edit

Availability of raw materials

For example, availability may cap the amount of gold that can be produced in a country regardless of
price. Likewise, the price of Van Gogh paintings is unlikely to affect their supply.

Length and complexity of production

Much depends on the complexity of the production process. Textile production is relatively simple. The
labor is largely unskilled and production facilities are little more than buildings – no special structures
are needed. Thus the PES for textiles is elastic. On the other hand, the PES for specific types of motor
vehicles is relatively inelastic. Auto manufacture is a multi-stage process that requires specialized
equipment, skilled labor, a large suppliers network and large R&D costs.
Mobility of factors

If the factors of production are easily available and if a producer producing one good can switch their
resources and put it towards the creation of a product in demand, then it can be said that the PES is
relatively elastic. The inverse applies to this, to make it relatively inelastic.

Time to respond

The more time a producer has to respond to price changes the more elastic the supply. Supply is
normally more elastic in the long run than in the short run for produced goods, since it is generally
assumed that in the long run all factors of production can be utilised to increase supply, whereas in the
short run only labor can be increased, and even then, changes may be prohibitively costly. For
example, a cotton farmer cannot immediately (i.e. in the short run) respond to an increase in the price
of soybeans because of the time it would take to procure the necessary land.

Inventories

A producer who has a supply of goods or available storage capacity can quickly increase supply to
market.

Spare/Excess Production Capacity

A producer who has unused capacity can (and will) quickly respond to price changes in his market
assuming that variable factors are readily available. The existence of spare capacity within a firm,
would be indicative of more proportionate response in quantity supplied to changes in price (hence
suggesting price elasticity). It indicates that the producer would be able to utilise spare factor markets
(factors of production) at its disposal and hence respond to changes in demand to match with supply.
The greater the extent of spare production capacity, the quicker suppliers can respond to price changes
and hence the more price elastic the good/service would be.

Various research methods are used to calculate price elasticities in real life, including analysis of historic
sales data, both public and private, and use of present-day surveys of customers' preferences to build up
test markets capable of modelling elasticity such changes. Alternatively, conjoint analysis (a ranking of
users' preferences which can then be statistically analysed) may be used.

Price elasticity of supply

Price elasticity of supply (PES) measures the responsiveness of quantity supplied to a change in price. It
is necessary for a firm to know how quickly, and effectively, it can respond to changing market
conditions, especially to price changes. The following equation can be used to calculate PES.
While the coefficient for PES is positive in value, it may range from 0, perfectly inelastic, to infinite,
perfectly elastic.

Consider the following example:

A firm’s market price increases from £1 to £1.10, and its supply increases from 10m to 12.5m. PES is:

+25 +10

= (+) 2.5

The positive sign reflects the fact that higher prices will act an incentive to supply more. Because the
coefficient is greater than one, PES is elastic and the firm is responsive to changes in price. This will give
it a competitive advantage over its rivals.

Price Elasticity of Supply

Price elasticity of supply (PES) is the measure of responsiveness of producers and resource suppliers to
the change in price of a produce or resource. The responsiveness of suppliers to price means the degree
to which they change their supply when the price of a product, service or a resource changes by a
certain amount. When suppliers are more responsive, they will change the quantity they supply by a
greater amount in response to a small change in price.

Percentage Change in Price

When using the above formula, the percentage changes in price and quantity supplied are calculated by
dividing the difference of initial price/quantity by the difference of final price/quantity respectively. But
this causes problem. For example, when price changes from \$4 to \$5 the percentage change in price is
\$1/\$5 = 20% but in case of opposite change from \$5 to \$4, the percentage change is -\$1/4 = -25%. The
same problem arises when calculating the percentage change in quantity supplied. Thus the price
elasticity of supply as calculated above is different for two opposite and equal changes.

We can avoid the above problem by using a more accurate formula called the mid-point formula of price
elasticity given below:

(Qi + Qf) ÷ 2 (Pi + Pf) ÷ 2

Where Qi is the initial quantity supplied, Qf is final quantity supplied, Pi is the initial price and Pf is the
final price.

The price elasticity of supply equals the slope of supply curve. Since the supply curve has positive slope
therefore the price elasticity of supply is always positive. Remember that price elasticity of demand is
negative.

Example

Calculate the price elasticity of supply using the mid-point formula when the price changes from \$5 to
\$6 and the quantity supplied changes from 20 units per supplier per week to 30 units per supplier per
week.

Solution

Percentage change in price = (\$6 − \$5) ÷ {(\$6 + \$5) ÷ 2} ≈ 18%

Price elasticity of supply ≈ 40% ÷ 18% = 2.22