Calculating Elasticity of Demand
Both demand and supply curves show the relationship between price and the number of units demanded or supplied. Price elasticity is the ratio between the percentage change in the quantity demanded, \[\text{Q}_d\], or supplied, \[\text{Q}_s\], and the corresponding percent change in price.
The price elasticity of demand is the percentage change in the quantity demanded of a good or service divided by the percentage change in the price. The price elasticity of supply is the percentage change in quantity supplied divided by the percentage change in price.
Elasticities can be usefully divided into five broad categories: perfectly elastic, elastic, perfectly inelastic, inelastic, and unitary. An elastic demand or elastic supply is one in which the elasticity is greater than one, indicating a high responsiveness to changes in price. An inelastic demand or inelastic supply is one in which elasticity is less than one, indicating low responsiveness to price changes. Unitary elasticities indicate proportional responsiveness of either demand or supply.
Perfectly elastic and perfectly inelastic refer to the two extremes of elasticity. Perfectly elastic means the response to price is complete and infinite: a change in price results in the quantity falling to zero. Perfectly inelastic means that there is no change in quantity at all when price changes.
If . . . It Is Called . . . \[\dfrac{\mathrm{\% ~ change~ in~ quantity}}{\mathrm{\% ~ change~ in~ price}}=\infty\] Perfectly elasti \[\dfrac{\mathrm{\% ~ change~ in~ quantity}}{\mathrm{\% ~ change~ in~ price}}>1\] Elastic \[\dfrac{\mathrm{\% ~ change~ in~ quantity}}{\mathrm{\% ~ change~ in~ price}}=1\] Unitary \[\dfrac{\mathrm{\% ~ change~ in~ quantity}}{\mathrm{\% ~ change~ in~ price}}<1\] Inelastic \[\dfrac{\mathrm{\% ~ change~ in~ quantity}}{\mathrm{\% ~ change~ in~ price}}=0\] Perfectly inelastic
Example
Understanding Elasticity of Demand Calculation
Elasticity of demand measures how the quantity demanded of a good or service changes in response to changes in price, income, or other factors. It is a crucial concept in economics, helping businesses and policymakers understand consumer behavior and market dynamics.
The key concepts in calculating elasticity of demand include:
- Price Elasticity of Demand (PED): Measures how the quantity demanded changes in response to price changes.
- Income Elasticity of Demand (YED): Measures how the quantity demanded changes with variations in consumer income.
- Cross-Price Elasticity of Demand (XED): Measures how the quantity demanded of one good changes when the price of another good changes.
- Elasticity Coefficient: The numerical representation of elasticity, indicating whether demand is elastic, inelastic, or unitary.
Calculating Elasticity of Demand
To calculate elasticity of demand, the following general formula is used:
- Elasticity Formula: \( \text{Elasticity} = \frac{\text{Percentage Change in Quantity Demanded}}{\text{Percentage Change in Price or Other Factor}} \)
- Percentage Change in Quantity Demanded: The change in quantity demanded expressed as a percentage of the original quantity.
- Percentage Change in Price: The change in price expressed as a percentage of the original price.
Example: If the price of a product increases by 10% and the quantity demanded decreases by 20%, the price elasticity of demand is:
\( \text{PED} = \frac{-20\%}{10\%} = -2 \)
This indicates that demand is elastic, as the absolute value of elasticity is greater than 1.
Factors Affecting Elasticity of Demand
Several factors influence demand elasticity:
- Availability of Substitutes: Goods with close substitutes tend to have higher elasticity.
- Necessity vs. Luxury: Necessities typically have inelastic demand, while luxuries have elastic demand.
- Proportion of Income: Goods that consume a larger share of income tend to have more elastic demand.
- Time Horizon: Demand is more elastic in the long run as consumers adjust their behavior.
Types of Elasticity of Demand
There are different types of demand elasticity:
- Price Elasticity of Demand (PED): Focuses on changes in price.
- Income Elasticity of Demand (YED): Reflects changes in consumer income.
- Cross-Price Elasticity of Demand (XED): Analyzes the impact of price changes in related goods.
Example: If the price of a substitute good decreases, the quantity demanded of the original good may decrease, resulting in a negative cross-price elasticity.
Real-life Applications of Elasticity of Demand
Elasticity of demand is used in various real-world scenarios:
- Helping businesses set optimal prices for maximizing revenue and profits.
- Informing government policies on taxation and subsidies.
- Understanding consumer responsiveness to economic changes, such as inflation or wage adjustments.
Common Operations in Elasticity of Demand Calculation
When calculating elasticity of demand, the following steps are common:
- Gather data on price, quantity demanded, and other relevant variables.
- Calculate percentage changes using the midpoint formula to ensure consistency.
- Apply the elasticity formula to compute the elasticity coefficient.
| Calculation Type | Description | Steps to Calculate | Example |
|---|---|---|---|
| Price Elasticity of Demand (PED) | Measures how the quantity demanded changes in response to a change in price. |
|
If the price of a product increases from $10 to $12 and quantity demanded decreases from 50 to 40 units:
|
| Income Elasticity of Demand (YED) | Measures how the quantity demanded changes as consumer income changes. |
|
If consumer income increases from $1,000 to $1,200 and quantity demanded increases from 100 to 120 units:
|
| Cross-Price Elasticity of Demand (XED) | Measures how the quantity demanded of one good changes in response to the price change of another good. |
|
If the price of Good B increases from $20 to $25 and the quantity demanded of Good A increases from 200 to 250 units:
|
| Elasticity of Demand Over Time | Analyzing changes in demand elasticity over time. |
|
If the price of a product decreases from $15 to $10 between 2020 and 2025, and quantity demanded increases from 300 to 500 units:
|
