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Point Elasticity: Method & Formula

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  • 0:00 The Law of Demand
  • 0:40 The Demand Curve
  • 1:19 Elasticity
  • 2:17 Point Elasticity of Demand
  • 5:51 Lesson Summary
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Lesson Transcript
Instructor: Shannon Battle

Shannon has taught middle school and college classes and has a law degree.

This lesson will discuss the law of demand and the demand curve. We will then build to point elasticity, the mathematical formula used to calculate it, and why point elasticity is useful in business.

The Law of Demand

Have you ever wondered how stores come up with prices? Business owners do not just randomly choose them. The law of demand is a tool business owners use to decide what price is best to sell their goods. The law of demand states that how many goods a customer will buy is related to the cost of the product.

Say, for example, you own a clothing store. You are going to sell a little black dress. If you price the dress at $0.00, you will sell all of them, but you won't make any money. If you price the dress at $1,000, you may sell not sell any! So where should you price the dress so that customers will buy them and you will make money?

The Demand Curve

To figure this out, we look at a demand curve. Demand is the willingness of a customer to buy a good. If a 50-inch flat screen television costs $800, you may not be willing to buy it. Here, the demand (willingness to buy) for the good (the television) is low.

However, if that same television costs $50, you would probably buy it whether you needed it or not! At this price, the demand for the good is high! Here, we use a demand curve, which demonstrates that when price goes down, demand goes up and when price goes up, demand goes down. Basically, the less a good costs, the more customers are willing to buy it.

Demand Curve: As price goes up, demand goes down.
demand curve

Elasticity

But prices rarely stay the same. At some point, most business owners need to adjust prices. How do you decide how to adjust the price? That's where the concept of elasticity comes in.

Elasticity measures how much the demand changes as the price changes. If a good is elastic; that means demand will change as price changes. Elastic goods are things like clothes, electronics and furniture - purchases that are not essential to daily life. While we may need clothes, electronics and furniture, we don't need new items. This means that if the price goes up, the demand goes down. For a business owner, this means fewer sales!

If a good is inelastic, that means the demand doesn't change as price changes. Examples of inelastic goods are gas, electricity and water. These purchases are essential to daily life. This means as price goes up, demand stays pretty much the same. As a business owner, the price won't really affect how much is sold.

Point Elasticity of Demand

Now, let's talk about point elasticity of demand. Point elasticity shows elasticity at a single point on the demand curve instead of showing a line.

Formula

So how do we measure elasticity? Well, there's a formula. Basically, we are just dividing the percent change in quantity demanded by the percent change in price. An answer greater than 1 means the good is elastic; an answer less than 1 means the good is inelastic.

formula

Example

Let's look at an example of how this works. We will continue with our little black dress example. Let's say we decided to sell our little black dress for $100. At $100, we can sell 10 dresses. We are thinking of increasing the price to $125. If we change the price to $125, we can sell 7 dresses. What is the elasticity of demand of our dress? To calculate, you have to know a specific set of numbers.

Information Needed Numbers from Example
The quantity that was demanded before the price change 10 dresses
The quantity that was demanded after the price change 7 dresses
The price before the price change $100
The price after the price change $125

Now that we have all the data we need, we follow five steps, starting by finding the top number for our formula:

Step (1): Calculate the change in demand (Quantity demanded after - Quantity demanded before)

  • 7 - 10 = -3

Step (2): Calculate the percent change in quantity demanded. Divide the change in quantity (your answer in Step 1) by the quantity demanded before the change.

  • -3 ÷ 10 = -.3, or 30%

This number says that our demand went down by 30%. Now we have the top number for our formula. It will be -.30.

Now, we will calculate our bottom number (the percent change in price) the same way but using the price numbers.

Step (3): Calculate the change in price (Price after - Price before)

  • 125 - 100 = 25

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