Calculation of Price Elasticity of Demand

Price Elasticity of Demand Calculator

elastic

inelastic

unit elastic

perfectly inelastic

Percentage Change in Price:

Percentage Change in Quantity Demanded:

Price Elasticity of Demand (PED):

Absolute PED:

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 changes.

Why is Price Elasticity of Demand Important?

For businesses, understanding PED is crucial for making informed decisions regarding pricing strategies, production levels, and revenue forecasting. For example:

• Pricing Strategy: If demand is elastic, a small price increase can lead to a significant drop in sales, potentially reducing total revenue. Conversely, a small price decrease might boost sales enough to increase total revenue. If demand is inelastic, a price increase might lead to higher revenue because the drop in quantity demanded is proportionally smaller.
• Revenue Optimization: Businesses can use PED to find the optimal price point that maximizes their total revenue.
• Policy Making: Governments use PED to predict the impact of taxes on goods (e.g., excise taxes on tobacco or alcohol) or subsidies on consumer behavior.

The Formula for Price Elasticity of Demand

The most common way to calculate PED is using the percentage change method:

PED = (% Change in Quantity Demanded) / (% Change in Price)

Where:

• % Change in Quantity Demanded = ((New Quantity - Original Quantity) / Original Quantity) * 100
• % Change in Price = ((New Price - Original Price) / Original Price) * 100

Interpreting the PED Value

The absolute value of PED determines the elasticity of demand:

• Elastic Demand (|PED| > 1): When the absolute value of PED is greater than 1, demand is considered elastic. This means that a given percentage change in price leads to a proportionally larger percentage change in quantity demanded. Products with many substitutes or luxury goods often have elastic demand.
• Inelastic Demand (|PED| < 1): When the absolute value of PED is less than 1, demand is considered inelastic. This means that a given percentage change in price leads to a proportionally smaller percentage change in quantity demanded. Necessities like basic food items or life-saving medicines often have inelastic demand.
• Unit Elastic Demand (|PED| = 1): When the absolute value of PED is exactly 1, demand is unit elastic. The percentage change in quantity demanded is exactly equal to the percentage change in price.
• Perfectly Inelastic Demand (|PED| = 0): Quantity demanded does not change at all, regardless of the price change. This is rare but can apply to essential goods with no substitutes, like certain life-saving drugs.
• Perfectly Elastic Demand (|PED| = Infinity): Consumers will demand an infinite quantity at a specific price, but zero quantity if the price increases even slightly. This is also rare and typically applies to perfectly competitive markets where individual firms are price takers.

Factors Influencing Price Elasticity of Demand

Several factors can influence whether demand for a product is elastic or inelastic:

1. Availability of Substitutes: The more substitutes available for a product, the more elastic its demand tends to be. If the price of one brand of coffee rises, consumers can easily switch to another.
2. Necessity vs. Luxury: Necessities (e.g., basic food, utilities) tend to have inelastic demand because consumers need them regardless of price. Luxury goods (e.g., designer clothes, exotic vacations) tend to have elastic demand.
3. Proportion of Income Spent: Products that represent a large portion of a consumer's income (e.g., a car) tend to have more elastic demand than those that represent a small portion (e.g., a pack of gum).
4. Time Horizon: Demand tends to be more elastic in the long run than in the short run. Consumers have more time to find substitutes or adjust their consumption habits. For example, if gas prices rise, people might initially pay more, but over time they might buy more fuel-efficient cars or use public transport.
5. Definition of the Market: The broader the definition of the market, the more inelastic the demand. For example, the demand for "food" is very inelastic, but the demand for "organic kale" might be quite elastic.

Example Calculation

Let's say a company sells widgets. Initially, the price is $10.00, and they sell 1,000 units. They decide to lower the price to $8.00, and as a result, they now sell 1,200 units.

• Original Price (P1) = $10.00
• New Price (P2) = $8.00
• Original Quantity (Q1) = 1,000 units
• New Quantity (Q2) = 1,200 units

Using the calculator above, you would input these values to find the PED.

Percentage Change in Price: ((8 – 10) / 10) * 100 = -20%

Percentage Change in Quantity Demanded: ((1200 – 1000) / 1000) * 100 = 20%

PED: 20% / -20% = -1

The absolute PED is 1, indicating unit elastic demand. This means the percentage change in quantity demanded is exactly equal to the percentage change in price.