Price Elasticity of Demand Definition and Formula

What is Price Elasticity of Demand

Price elasticity of demand is a measure of how a quantity of demand responds to a change in price. The price elasticity of demand can be calculated by dividing the percentage change of quantity by the percentage change in price.

The price elasticity of demand shows us exactly how the quantity of demand is affected by the price change. For example, A price elasticity of demand of 0.5 means that a 10% increase in price will lead to a 5% decline in the quantity demanded. Higher elasticity number, the quantity responds more to price change.

It is the most commonly used elasticity of demand concept. Normally, the price elasticity of demand helps the company to price its products. This helps the company understand the customer’s behavior and sensitivity to price changes.

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Key Points

• The price elasticity reflects how the quantity of demand is affected by the price change.
• Price elasticity of demand can be calculated by dividing the percentage change of quantity by the percentage change in price.
• The higher number means the quantity responds more to price changes.

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Price Elasticity of Demand Formula

The price elasticity of demand can be calculated by dividing the percentage change of quantity demand by the percentage change in price, or the following equation:

ED = Percentage change of quantity demanded ÷ Percentage change in price

where:

• ED = Price elasticity of demand
• Percentage change of quantity demanded is the change in quantity demanded of a product compared to the previous value.
• Percentage change in price is the price of a product compared with the previous price.

How the percentage change works (and how to calculate the percentage change).

Price Elasticity of Demand Example

Example 1: When gasoline prices rose by 10%, the quantity demand for gasoline fell by 30%.

Price elasticity of demand = 30 ÷ 10 = 3

Example 2: The price of a good rise by 20% and, in response, quantity demanded falls by 10%.

Price elasticity of demand = 10 ÷ 20 = 0.5

As you can see, the more numerical a price elasticity of demand, the quantity responds more to price changes.

Elastic and Inelastic of Demand

The price elasticity of demand can be classified be relative responsiveness by the terms elastic and inelastic.

The demand is elastic when the percentage change in quantity demand is more than the percentage change in price (E > 1). Conversely, demand is inelastic when the percentage change in quantity demand is less than the percentage change in price (E > 1).

• Elastic (E > 1): The quantity demand changes much more than the price change.
• Inelastic (E < 1): The quantity demand doesn’t change much with a price change.

In the first example above, the price elasticity of demand of 3 means demand is elastic, and the price elasticity of demand of 0.5 means demand is inelastic.

References: Federal Reserve Bank of St. Louis