Price Elasticity Of Demand: X X X X

Price elasticity of demand §The price elasticity of a good measures the responsiveness of the quantity demanded of the good to changes in the price of that good. §It is the percentage change in the quantity demanded (ΔD x /D x )divided by percentage change in the price (ΔP x /P x )of the commodity.

Determining Price Elasticity Ep=

Ep=

Percentage Change in Quantity ___________________________________ Percentage Change in Price Change in Quantity Quantity ____________________________________ Change in Price Price

Factors influencing the price elasticity of demand Availability of substitutes: greater the number

of substitutes, greater the elasticity. Degree of necessity or luxury: Luxury products tend to have grater elasticity than necessities. Proportion of income required by the item: Products requiring a large amount of consumers income tend to have greater elasticity. Time period considered: Elasticity tends to be greater over the long run because consumers have more time to adjust their behaviour to price changes.

Examples: The demand for automobiles would, in the

short term, be somewhat elastic, as the purchase of a new vehicle can often be delayed. The demand for a specific model automobile would likely be highly elastic, because there are so many substiutes. The demand for automobiles in rural areas would probably be inelastic, since there are few alternative modes of transportation.

Examples: Schooling itself is considered an essential

service by most parents, and better schools are so desirable to many parents that they undertake considerable sacrifices to send their children to alternative schools. This would tend to produce a highly inelastic demand. However, there is also a widely available substitute for alternative schools, namely the traditional public schools. For most goods and services, the availability of substitutes produces a highly elastic demand

. Estimated Price Elasticities of Demand for Various Goods and Services

Approx unitary elastic

Elastic

Source: Economics: Private and Public Choice, James D. Gwartney and Richard L. Stroup, eighth edition 1997

Price elasticity & total revenue Why do we care whether a good is elastic or

inelastic? The elasticity can tell us something about what happens to total revenue as price changes

Important Observations: When demand is elastic, a decrease

in price will result is an increase in the revenue (sales). When demand is inelastic, a decrease in price will result is a decrease in the revenue (sales). When demand is unit-elastic, an increase (or a decrease) in price will not change the revenue (sales).

Relationship between total revenue & price elasticity of demand When the demand curve is inelastic, a price

increase raises total revenue, while a price decrease reduces total revenue. When the demand curve is elastic, a price increase reduces total revenue, while a price decrease raises total revenue. When the demand curve is unit elastic, a price change does not affect total revenue.