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What is Price Elasticity of Demand?
Price elasticity of demand measures how responsive the quantity demanded of a good or service is to a change in its price.
Definition
Price elasticity of demand is an economic measure that shows the percentage change in quantity demanded resulting from a percentage change in price.
Key Takeaways
- Indicates how sensitive consumers are to price changes.
- Helps businesses predict revenue impacts of price adjustments.
- Varies by product type, availability of substitutes, and necessity.
Understanding Price Elasticity of Demand
Price elasticity of demand explains consumer behavior in response to price changes. When demand is elastic, small price changes lead to large changes in quantity demanded. When demand is inelastic, price changes have little effect on quantity demanded.
Elasticity depends on factors such as the availability of substitutes, whether a product is a necessity or luxury, time horizon, and proportion of income spent. Essential goods like medicine often have inelastic demand, while discretionary items tend to be elastic.
Businesses and policymakers use elasticity to design pricing strategies, tax policies, and subsidy programs.
Formula (If Applicable)
Price Elasticity of Demand (PED):
PED = (% Change in Quantity Demanded) / (% Change in Price)
Real-World Example
If a 10% price increase leads to a 20% drop in quantity demanded, the price elasticity of demand is:
PED = -20% / 10% = -2
This indicates elastic demand.
Importance in Business or Economics
Price elasticity of demand helps firms optimize pricing, forecast revenue, and understand customer behavior. Governments rely on elasticity to predict tax revenue, inflation effects, and consumer welfare impacts.
Types or Variations
Elastic Demand: Quantity demanded responds strongly to price changes.
Inelastic Demand: Quantity demanded changes little when prices change.
Unitary Elastic Demand: Quantity demanded changes proportionally to price.
Related Terms
- Demand Curve
- Price Elasticity of Supply
- Revenue Maximization
Sources and Further Reading
- Investopedia — Price Elasticity of Demand
- Khan Academy — Elasticity of Demand
- OECD — Market Behavior and Pricing
Quick Reference
- Measures responsiveness of demand to price.
- Influences pricing and tax decisions.
- Central concept in microeconomics.
Frequently Asked Questions (FAQs)
What does elastic demand mean?
Elastic demand means consumers are highly responsive to price changes.
Why is elasticity important for pricing?
It helps determine whether raising prices will increase or decrease total revenue.
Can elasticity change over time?
Yes. Demand often becomes more elastic over longer time horizons.
