Introduction
Price Elasticity of Demand can be defined as the degree to which the effective desire for a commodity changes as the Price of that commodity varies. Generally, it has been observed that willingness to buy a certain commodity changes as those things become more expensive. The Price change of a commodity also affects its Demand.
We can find the Elasticity of Demand, or the responsive degree of Demand by comparing the percentage of change in Price with the quantity of the Demand of that commodity. In this article, we shall look at the concept of the Price of Elasticity of Demand.
The Formula for Price Elasticity of Demand
The Price Elasticity of Demand can be defined as an economic measure of the change in the quantity demanded or purchased of the product concerning its Price change. Mathematically, the Price Elasticity of the Demand formula can be explained as:
The Price Elasticity of Demand formula is = \[\frac{\text{% Change in Quantity Demanded}}{\text{% Change in Price}}\]
The cross-Price Elasticity of Demand is also an economic concept that measures the responsiveness in quantity demanded of one good when the Price for other good changes. This measurement is calculated by taking the percentage change in the quantity demanded of a particular good divided by the percentage change in the Price of the other good.
To calculate the Price Elasticity of Demand , we divide the change in quantity by initial quantity to calculate a percentage. If there is a Price rise from 50 to 70, we divide 20/50 = 0.4 = 40%.
FAQs on Price Elasticity of Demand: Key Insights
1. What is meant by price elasticity of demand and how is it calculated?
Price elasticity of demand is an economic measure of how responsive the quantity demanded of a good is to a change in its price. It shows the percentage change in quantity demanded in response to a one percent change in price. The formula to calculate it is:
Price Elasticity of Demand (Ed) = (% Change in Quantity Demanded) / (% Change in Price).
2. What are the key factors that determine the price elasticity of demand for a product?
Several factors influence the price elasticity of demand for a good. The primary determinants include:
- Availability of close substitutes: The more substitutes available, the more elastic the demand.
- Nature of the commodity: Necessities (like salt, medicine) tend to have inelastic demand, while luxuries have elastic demand.
- Proportion of income spent: Goods that constitute a small fraction of a consumer's budget typically have inelastic demand.
- Time period: Demand tends to be more elastic over a longer period as consumers have more time to find substitutes.
3. What are the five degrees of price elasticity of demand?
The five degrees of price elasticity of demand describe how demand responds to price changes:
- Perfectly Elastic Demand (Ed = ∞): An infinitesimally small change in price leads to an infinitely large change in quantity demanded. The demand curve is a horizontal line.
- Perfectly Inelastic Demand (Ed = 0): A change in price causes no change in the quantity demanded. The demand curve is a vertical line.
- Relatively Elastic Demand (Ed > 1): The percentage change in quantity demanded is greater than the percentage change in price.
- Relatively Inelastic Demand (Ed < 1): The percentage change in quantity demanded is less than the percentage change in price.
- Unitary Elastic Demand (Ed = 1): The percentage change in quantity demanded is exactly equal to the percentage change in price.
4. Why is understanding the price elasticity of demand important for a business?
Understanding price elasticity is crucial for businesses, especially for pricing strategies. If demand for a product is elastic (Ed > 1), a price decrease could lead to a significant increase in quantity demanded, potentially raising total revenue. Conversely, if demand is inelastic (Ed < 1), a business can increase its price without losing many customers, thus increasing total revenue. It helps in forecasting sales and making decisions about production levels.
5. Why is the demand for essential goods like life-saving medicines often inelastic?
The demand for essential goods like life-saving medicines is highly inelastic because they are necessities with few or no close substitutes. Consumers will continue to purchase them even if the price increases significantly, as their health and well-being depend on it. The urgency and importance of the product far outweigh the consideration of its price, leading to a very low responsiveness of demand to price changes.
6. How does the availability of substitutes fundamentally change a product's price elasticity?
The availability of close substitutes is one of the most powerful determinants of price elasticity. When a product has many substitutes (e.g., different brands of coffee), a small increase in its price will cause consumers to switch to the cheaper alternatives, making its demand highly elastic. In contrast, a product with no close substitutes (e.g., tap water from a single utility) will have highly inelastic demand because consumers have no other option to switch to if the price rises.
7. What is the main difference between price elasticity and cross elasticity of demand?
The main difference lies in the variables being measured. Price elasticity of demand measures the responsiveness of the quantity demanded of a good to a change in its own price. In contrast, cross elasticity of demand measures the responsiveness of the quantity demanded of one good to a change in the price of another good. It helps determine if goods are substitutes (positive cross elasticity) or complements (negative cross elasticity).
