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What is Price Elasticity of Demand?
Tricia Christensen
Tricia Christensen
Price elasticity of demand refers to the way prices change in relationship to the demand, or the way demand changes in relationship to pricing. Price elasticity can also reference the amount of money each individual consumer is willing to pay for something. People with lower incomes tend to have lower price elasticity, because they have less money to spend. A person with a higher income is thought to have higher price elasticity, since he can afford to spend more. In both cases, ability to pay is negotiated by the intrinsic value of what is being sold. If the thing being sold is in high demand, even a consumer with low price elasticity is usually willing to pay higher prices.
Elasticity implies stretch and flexibility. The price flexibility or the elasticity of demand will change based on each item. Changing nature of both price and demand are affected by a number of factors.
Generally, goods or services offered at a lower price lead to a demand for greater quantity. If you can get socks on sale you might buy several pairs or several packages, instead of just a pair. This means that though the seller offers the socks at a lower price, he usually ends up making more money, because demand for the product has increased. However if the price is set too low, the retailer may lose money by selling too many pairs of socks at a reduced rate.
Price elasticity of demand evaluates how change in price influences demand. In certain circumstances, demand remains inelastic, despite higher prices. This is true of a number of medications that are available to treat certain conditions, where there is no substitute. Demand remains constant in spite of high prices.
It’s also true of fuel consumption, where few substitutes exist. In 2006, when gasoline prices skyrocketed, demand for gasoline was only slightly affected. Some people were able to use less gas for their cars, or to purchase cars that were hybrids, but these were in short supply. Since few alternatives existed, people continued to buy gasoline, and demand was thus considered inelastic. Price didn’t significantly alter demand. Other utilities, like water, often are highly inelastic in price because they have no substitute to which a consumer can turn.
Price elasticity of demand also explains that price becomes more elastic, when higher prices may turn away most consumers who can choose to buy something else that is less expensive. When a good or service has numerous substitutes, prices are more elastic and will change with demand. In fact, availability of substitution is often a better predictor of price elasticity than is demand. Amount of competition, numerous companies offering the same items, can also affect price flexibility of demand. Usually, competition in the marketplace keeps prices lower and more flexible. Generic equivalents of certain items have lowered the demand for brand name items, thus lowering their price.
In economics, complex formulas show how the price elasticity of demand can be either profitable or detrimental to the seller. These formulas describe how good or bad price elasticity of demand functions. Examples of good (for the seller) price elasticity of demand include inelastic pricing. In this example, a small drop in demand is made up for by higher prices. A unit price elasticity that raises demand can also be profitable for a company. On the other hand, bad price elasticity occurs when quantity demand increases, but does not make up for discounted price, causing a drop in company profits.
A perfectly elastic price is equally detrimental. Raised price in the good eliminates demand completely. The most profitable arrangement in pricing is when demand is perfectly inelastic, as with the medicine and utilities cited above. Despite rise in price, demand does not decrease, resulting in the highest profits for a company.
Tricia Christensen
Tricia has a Literature degree from Sonoma State University and has been a frequent SmartCapitalMind contributor for many years. She is especially passionate about reading and writing, although her other interests include medicine, art, film, history, politics, ethics, and religion. Tricia lives in Northern California and is currently working on her first novel.
Learn more...
Tricia Christensen
Tricia has a Literature degree from Sonoma State University and has been a frequent SmartCapitalMind contributor for many years. She is especially passionate about reading and writing, although her other interests include medicine, art, film, history, politics, ethics, and religion. Tricia lives in Northern California and is currently working on her first novel.
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![Prescription medications are inelastic products where demand remains high despite higher prices.]()
By: KenishirotiePrescription medications are inelastic products where demand remains high despite higher prices. -
![Offering items on sale generally creates higher demand for them.]()
By: KenishirotieOffering items on sale generally creates higher demand for them. -
![Products for which there are many substitutes, such as soft drinks, are elastic where demand will drop because of higher prices.]()
By: Deyan GeorgievProducts for which there are many substitutes, such as soft drinks, are elastic where demand will drop because of higher prices. -
![Gas prices are relatively inelastic, since there aren't a lot of alternative fuels.]()
By: sintGas prices are relatively inelastic, since there aren't a lot of alternative fuels.
Discussion Comments
Between 1999 and 2000, the quantity of automobiles produced and sold declined by 20 percent. During this period, the real price of cars increased by 5 percent, real income levels declined by 2 percent and the real cost of gasoline increased by 20 percent. Given that the income elasticity of demand is +1.5 and the cross-price elasticity of gasoline and cars is -0.3;
(i) Compute the impact of the decline in real income on the demand for cars
(ii) Compute the impact of the gasoline price increase on the demand for cars
(iii) Compute the price elasticity of demand for cars during this period.
When the price of gadgets rises by 10 percent, demand for widgets falls by 30 percent. So what is the cross price of the elasticity of widgets and gadgets?
A company cuts price by £15 to £8. If they have a PED of 1.6 and original demand 30 units? My answer shows revenue falling when it should actually rise. What is wrong?
As the sales manager of an appliance store, you sometimes visit outlets run by your competitors. Six months ago you notice that their prices were very close to yours. Yesterday, you observed that their price have decreased and yours have not. Nevertheless your total unit sales have increased over this period. Assuming rational buyers and no deceptive advertising, how can you account for this?
An athletic director at a college recently raised ticket prices from $8 to $10 per game. Sales went down 10 percent. The director said "... with the 25 percent increase in ticket prices, dollar volume has increased about 12 percent." Is this claim consistent with what you know about demand elasticity? Find the elasticity of demand in this case, assuming the demand schedule is stable.
In 1977 Brazil was supplying about one-third of the world's coffee exports. When a frost wiped out about 75 percent of Brazil's 1976-77 crop, the price of green (unroasted) coffee rose by 400 percent. What was the approximate price elasticity of demand for coffee? Why was it so low?
According to recent studies at M.I.T. and the University of Michigan, a 10 percent increase in the price of cigarettes leads to a 14 percent drop in sales to teenagers. What is the elasticity of demand for cigarettes among teenagers? Would you expect it to be this high for older smokers? Explain your answers.
Using the midpoint elasticity of demand formula, find the price elasticity of demand for the following situation: When the price of cellular phones was $200, total sales in Ohio were 3,500. When the price fell to $180, sales rose to 3,800.
In August, 1990, East German taxicab drivers were on strike demanding lower cab fares. What must the drivers have believed about the price elasticity of demand for taxi rides?
This is the explanation of anon20095 Q2, right answer is 'E' only since the question says total expenditure on CDs stays the same and it is possible only if on declining the price, demand is increasing in same proportion, i.e., demand is unit price elastic.
Please help.
The demand curve for the daily edition of the SUN is QD = 85,000 – 30,000P. The current price of the newspaper is R0.50. Derive the Consumer Surplus for the newspaper.
can you help me to answer q12?
Between 2000 and 2005, the quantity of automobile produced and sold declined by 20 percent. During this period the real price of cars increased by 5 percent, real income levels declined by 2 percent, and the real cost of gasoline increased by 20 percent. Knowing that the income elasticity of demand is +1.5 and the cross price elasticity of gasoline and cars is -0.3,
a) Compute the impact of the decline in real income levels on the demand for cars.
b) Compute the impact of the gasoline price increase on the demand for cars.
c) Compute the price elasticity of the demand for cars during this period.
a company produces an electronic timing switch that is used in consumer and commercial products made by several other manufacturing firms. The fixed cost is $70000 per month and variable cost is $40 per unit The selling price per unit is p=$210 - 0.02(D) 1) Find the volumes at which break evens occur and At which value of D is total revenues maximized?
Between 2000 and 2005, the quantity of automobile produced and sold declined by 20 percent. During this period the real price of cars increased by 5 percent, real income levels declined by 2 percent, and the real cost of gasoline increased by 20 percent. Knowing that the income elasticity of demand is +1.5 and the cross price elasticity of gasoline and cars is -0.3,
a) Compute the impact of the decline in real income levels on the demand for cars.
b) Compute the impact of the gasoline price increase on the demand for cars.
c) Compute the price elasticity of the demand for cars during this period.
If the demand function for an item is Qd = 1000 - 10P, how do you find the price elasticity of demand at a price of $100?
To DMathews: Given the formula of price elasticity:
e=percentage change in quantity/percentage change in price
=(30/100)/(6/21)
=30*21/600
=21/20
with a negative sign, because price falls.
what are the examples of the categories of elasticity, please? i do not understand this unit.
The cigarette market in city XYZ is currently in equilibrium, with the equilibrium price being $10 per pack and the equilibrium quantity being 200 packs. At the equilibrium point, the price elasticity of demand for cigarettes is Ed = -0:1 and the price elasticity of supply for cigarettes is Es = 1.
Suppose the demand curve is represented by P = bandnd the supply curve is represented by P = c dQdQ, where P denotes price and Q denotes quantity. Please find the values for a, b, c and d.
@anon20095: It should be unit price elastic because in this case since the total expenditure remains the same after the price fall, the percent of increase in quantity demanded will be equal to the percent decrease in price.
This is an answer to anon20095:
Let Y be the number of compact disks bought and P be the price of a compact disk. Expenditure is equal to Y*P. We then differentiate this with respect to P using the product rule. The result is:
d(Y*P)/dP = (dY/dP)*P + Y.
This makes intuitive sense. When there is an increase in the price of a compact disk by one unit, we pay an extra unit for the current number of units bought (Y), but we also change our demand for the number of compact disks to be bought and this impacts expenditure ((dY/dP)*P)).
So, if expenditure stays the same after a price increase, then:
d(Y*P)/dP = (dY/dP)*P + Y = 0
If we re-arrange this, then ((dY)/Y)/((dP)/P)=-1
so that the price elasticity of demand is one.
how does price elasticity of demand affects the decision making of the consumer and of the organization?
I have a question that I don't understand- If a company reduces the prices of CD's from $21 to an average of $15 and the company is expecting the price cut to boost the quantity of CD's sold by 30%. What formula do I use to find the estimate of the price elasticity of demand for CD's?
There is a question in my book that goes like this: Assume that a consumer finds that her total expenditure on compact discs stays the same after the price of compact discs declines. Which of the following is true for this consumer over the price range?
a - compact discs are inferior goods
b - the consumer's demand for cds increased
c - the consumer's demand for cds is perfectly price elastic
d - the consumer's demand for cds is perfectly price inelastic
e - the consumer's demand for cds is unit price elastic
The answer in the key is "E", I say it is "D", why would it be "E"?
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