Price elasticity of demand is a measure that tells us how sensitive the quantity demanded of a certain good is to changes in its price. The normal formula for calculating price elasticity of demand is PED = %ΔQ / %ΔP, where
PED is price elasticity of demand,
%ΔQ is the change in quantity demanded of the good,
%ΔP is the percentage change in price.
Price elasticity of demand in economics
In economics, Price elasticity of demand is the % change in the quantity demanded of a good or service relative to a one percent change in its price. This concept is used as an indication of how responsive buyers are with respect to changes in changing prices.
Price elasticity is measured as
Price Elasticity Of Demand = % Change In Quantity Demanded / % Change In Price
You can use the midpoint formula to calculate the price elasticity of demand between two points.
Price Elasticity Of Demand Midpoint Formula
Let’s assume that the original price is P1, quantity demanded is Q1 and new price is P2, quantity demanded is Q2. Using these values we can calculate the price elasticity using midpoint formula as shown below-
Percentage change in Quantity Demanded = [(Q2 – Q1)/((Q1+Q2)/2)] x 100
Percentage change in Price = [(P2 – P1)/((P1+P2)/2)] x 100
PED (price elasticity of demand using midpoint formula) = Percentage change in Quantity Demanded/Percentage change in Price
Exercises on how to calculate price elasticity of demand using midpoint method:
Calculate the price elasticity of demand using midpoint formula.
Original Price = $2,
New Price = $1.50
Original quantity demanded = 20
New quantity demanded = 40
% Change In Quantity Demanded = [(Q2 – Q1)/((Q1+Q2)/2)] x 100
= [(40 – 20)/((20+40)/2)] x 100
= (20/30)*100 = 66.67%
% Change in Price = [(P2 – P1)/((P1+P2)/2)] x 100
= [ (1.50-2.00) / ((1.50+2.00)/2) ] x 100 = -28.57142857142
Price Elasticity Of Demand Midpoint Method = |( % Change In Quantity Demanded / % Change In Price ) |
= 66.67%/-28.57%= -2.33
Thus price elasticity of demand using midpoint method is 2.33.
Other important things to note:
Elasticity in economics is the degree of responsiveness in the quantity demanded or supplied with respect to changes in its respective price.
Elasticity can be calculated using various formula such as point, midpoint and arc elasticity of demand.
Price elasticity of demand is a negative number because lower prices leads to higher demand and vice versa. Thus when PED is positive it implies that Demand is Inelastic while when PED is negative it implies that Demand is Elastic.
Variables affecting Price Elasticity Of Demand:
Availability of Substitutes: If there are many substitutes for a good , the consumers compare the price between two or more goods, if this comparison shows that they can get more value from another product they will switch from one product to other hence the consumer
If there are very few substitutes available to a particular product, the consumer will not be as responsive as they would be to a product with many substitutes. This is because they won’t have as much choice or variety of products that they can switch to if they don’t like the price of one product.
Income: The people with high income tends to spend more on demand sensitive goods and vice versa, thus the higher the income of buyers, greater will be their responsiveness to a change in prices which leads to higher elasticity.
Price expectations: Price expectations influence how much quantity demanded for a good. For example if you expect oil prices to rise , you’ll start carpooling/buying smaller cars now rather than later, this anticipation of price increases causes an increase in quantity demanded which leads to higher elasticity.
Number of buyers: The more the consumers, the more likely is a good with high PED, this is due to consumer’s ability to compare between different products and switch to other product which has a lower price.
PED is used by firms as well as governments across the world when setting or revising tax rates on products/services. It allows market players better understand how competitors operate in their markets thus allowing them to better strategize for their future.