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Price Elasticity of Demand: Definition, Formula & Example

Price Elasticity of Demand: Definition, Formula & Example
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  • 0:03 Price Elasticity of…
  • 0:33 Inealistic and Elastic
  • 1:54 Formula
  • 5:06 Why Is It Important?
  • 5:33 Lesson Summary
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Lesson Transcript
Instructor: Ellie Funke
This lesson will provide a clear definition of price elasticity of demand, show you step-by-step how to calculate it using the formula, and why this formula is important to a firm when setting prices. Afterwards, check out the quiz.

Price Elasticity of Demand Defined

Price elasticity of demand is the relationship of consumer response to change in price of a product or service. The degree of change along the demand curve relative to the degree of change in price will more clearly show the effect of a price change. The formula:

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

provides the change for unit demand for each unit change in price.

Inelastic and Elastic

Some products are more sensitive to increases, like bread or sorbet that may be easily substituted. Other products that are relatively inelastic include products that exist in a market without competition, like utilities, or necessities, like healthcare and some prescriptions.

When a product is inelastic, there will be less variation in demand relative to a variation in price. If the coefficient is < 1, then it's considered inelastic. This means the buyer isn't as sensitive to a price change.

Unit elasticity occurs when the same percentage is found for the change in price as for the change in demand. Whether it's a decrease in demand or an increase in demand, we can say that a proportionally equivalent change is considered unit elasticity. This means that for every unit percent of change in price, the buyer responds to an equivalent unit of change in quantity demanded.

Elastic demand curve

When a product or service is elastic, the coefficient is > 1. The graph shows what the demand curve looks like when it is elastic. When the price of the product goes down 33%, consumers respond by increasing quantity demanded by 110%. Since 1.10 / .33 is greater than 1, it is considered elastic.

Formula

To figure out price elasticity, we look at the formula where E(sub)d is price elasticity of demand and see it is found in the percent of change in quantity demanded divided by the percent of change in price.

E(sub)d = ((Qd2 -Qd1 ) / Qd1) / ((P2 - P1) / P1)

E(sub)d = Price elasticity of demand

Qd1 = Original quantity demanded

Qd2 = Quantity demanded after the change in price

P1 = Original price

P2 = Price after change

Comparing the percentages of change for each variable, Qd and P, tells us more about the relativity than if we compared just the value of the change.

Here is an example of how to figure the price elasticity of demand:

Your sole source power company has increased your unit cost of electricity 25%. You may start turning off lights, stop blow-drying your hair, and turn down the thermostat. With your new bill, we calculate the price elasticity of electricity.

We have the percentage change in price for a kWh. Now we need to find the percentage change in quantity demanded.

Last month kWh used = 1,500

This month kWh used = 1,200

Delta of Q = 1,500 - 1,200 = 300; 300 / 1,500 = 20%.

Delta of P = 25%

Now that we have the first two parts of the formula, we can easily calculate the last part.

E(sub)d = .20 / .25 = .80

The price elasticity of the demand for electricity is .80. Since that is less than one, we can determine that it is inelastic.

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