Price Elasticity of Demand

Definition of Price Elasticity

Price elasticity measures how the quantity demanded of a good responds to a change in its price. The formula for price elasticity of demand (E_p) is:

E_p = \frac{\text{Percent Change in Quantity Demanded}}{\text{Percent Change in Price}}

Understanding the Elasticity Coefficient (E_p)

The elasticity coefficient provides critical information about demand sensitivity:

• Elastic Demand: If the absolute value of Ep is greater than 1 ( |Ep| > 1), consumers are highly sensitive to price changes.

• Inelastic Demand: If the absolute value of Ep is less than 1 (|Ep| < 1), consumers are less sensitive to price fluctuations.

Interpretation of Demand Sensitivity

Elastic Demand

Occurs when consumers are relatively more responsive to price changes, resulting in a percentage change in quantity demanded that is greater than the percentage change in price.

• Example: If the price decreases by 10% and quantity demanded increases by 20%:
  E_p = \frac{20\%}{10\%} = 2

• Since |E_p| > 1, the demand is elastic.

Inelastic Demand

Occurs when consumers are relatively less responsive to price changes, resulting in a percentage change in quantity demanded that is less than the percentage change in price.

• Example: If the price increases by 10% and quantity demanded decreases by only 5%:
  E_p = \frac{-5\%}{10\%} = -0.5

• Since |E_p| < 1, the demand is inelastic.

Classification of Elasticity

• Elastic (> 1): Demand is sensitive; quantity demanded changes significantly even with small price shifts.

• Unitary Elastic (= 1): Quantity demanded changes are exactly proportional to price changes.

• Inelastic (< 1): Demand is insensitive; quantity demanded changes minimally despite price fluctuations.

Key Takeaways

• Numerical Thresholds:

  • Elastic when E_p > 1

  • Inelastic when E_p < 1

  • Unitary when E_p = 1

• Consumer Behavior: Elasticity is influenced by how much quantity changes in relation to price, reflecting specific behaviors in different markets.