Price Elasticity of Demand Calculator
Results:
Price Elasticity of Demand (PED):
Interpretation:
Understanding Price Elasticity of Demand
Price Elasticity of Demand (PED) is a fundamental concept in economics that measures the responsiveness of the quantity demanded for a good or service to a change in its price. In simpler terms, it tells us how much the demand for a product changes when its price goes up or down.
Why is PED Important?
For businesses, understanding PED is crucial for making informed decisions about pricing strategies, revenue forecasting, and marketing. If a product is highly elastic, a small price increase could lead to a significant drop in sales. Conversely, if a product is inelastic, a price increase might not deter many customers, potentially increasing revenue.
The Formula for Price Elasticity of Demand (Midpoint Method)
The most common way to calculate PED, especially when dealing with discrete price and quantity changes, is using the Midpoint Method (also known as Arc Elasticity). This method provides a more accurate measure by using the average of the initial and new prices and quantities, making the elasticity value the same whether the price increases or decreases.
The formula is:
PED = [ (Q2 - Q1) / ((Q1 + Q2) / 2) ] / [ (P2 - P1) / ((P1 + P2) / 2) ]
Where:
- Q1 = Original Quantity Demanded
- Q2 = New Quantity Demanded
- P1 = Original Price
- P2 = New Price
Interpreting the PED Value
The absolute value of PED helps us categorize the demand for a product:
- PED > 1 (Elastic Demand): When the absolute value of PED is greater than 1, demand is considered elastic. This means that the percentage change in quantity demanded is greater than the percentage change in price. Consumers are highly responsive to price changes. For example, if the price of a luxury car increases by 10%, and demand falls by 20%, the PED is 2 (elastic).
- PED < 1 (Inelastic Demand): When the absolute value of PED is less than 1, demand is considered inelastic. This means the percentage change in quantity demanded is less than the percentage change in price. Consumers are not very responsive to price changes. For example, if the price of essential medicine increases by 10%, and demand falls by only 2%, the PED is 0.2 (inelastic).
- PED = 1 (Unit Elastic Demand): When the absolute value of PED is exactly 1, demand is unit elastic. The percentage change in quantity demanded is equal to the percentage change in price.
- PED = 0 (Perfectly Inelastic Demand): Demand does not change at all, regardless of the price change. This is rare but can apply to life-saving drugs with no substitutes.
- PED = Infinity (Perfectly Elastic Demand): An infinitesimal change in price leads to an infinite change in quantity demanded. This is typical for products in perfectly competitive markets where consumers have many identical alternatives.
Example Calculation
Let's say a coffee shop sells 100 cups of coffee per day at an original price of $3.00 per cup. When they lower the price to $2.50 per cup, their sales increase to 130 cups per day.
- P1 = $3.00
- P2 = $2.50
- Q1 = 100 cups
- Q2 = 130 cups
Using the Midpoint Formula:
Percentage Change in Quantity = (130 - 100) / ((100 + 130) / 2) = 30 / 115 ≈ 0.26087
Percentage Change in Price = (2.50 - 3.00) / ((3.00 + 2.50) / 2) = -0.50 / 2.75 ≈ -0.18182
PED = |0.26087 / -0.18182| ≈ 1.435
In this example, the PED is approximately 1.435, which is greater than 1. This indicates that the demand for coffee at this shop is elastic. A decrease in price led to a proportionally larger increase in quantity demanded.
Use the calculator above to quickly determine the Price Elasticity of Demand for your products or services based on changes in price and quantity.