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In other words, it measures how much people react to a change in the price of an item.

Price elasticity of demand refers to how changes to price affect the quantity demanded of a good.

Conversely, price elasticity of supply refers to how changes in price affect the quantity supplied of a good.

Price Elasticity of Demand There are three main types of price elasticity of demand: elastic, unit elastic, and inelastic.

Before delving deeper into the subject, a sound understanding of the laws of supply and demand Supply and Demand The laws of supply and demand are microeconomic concepts that state that in efficient markets, the quantity supplied of a good and quantity is recommended.

To calculate the Price Elasticity of Demand (PED), we use the following equation: Where: Change in Quantity Demanded (Qd) (New Quantity Old Quantity)Average Quantity Change in Price (P) (New Price Old Price)Average Price PED is always provided as an absolute value, or positive value, as we are interested in its magnitude.

Midpoint Method for Elasticity Some economics resources will instead calculate price elasticity using the following formulas: Change in Quantity Demanded (Qd) (New Quantity Old Quantity) Old Quantity Change in Price (P) (New Price Old Price) Old Price Notice that the denominators for both of these are the old quantity and price as opposed to the average price and quantity that was shown above.

Using this formula is not ideal because the direction of the change in price or quantity can affect the number calculated for price elasticity.

The cost of a pair of pants drops from 30 to 20 and the quantity demanded goes from 100 to 150 pairs of pants.

The price elasticity of demand calculation for this would be as follows: However, if we flip this example and the pair of pants is increasing in price, we get this calculation instead: In this example, the numbers mentioned are the same, and the change is the exact same.

The only difference is that the direction of the changes is different, causing different price elasticities of demand.

To solve this, the formula that we use above employs the midpoint method for elasticity.

The midpoint method uses the average quantity and price as the denominators for the percentage change formulas as follows: Change in Quantity Demanded (Qd) (New Quantity Old Quantity) Average Quantity Change in Price (P) (New Price Old Price) Average Price This solves the problem of the differing elasticities, as we can see using the following calculations for the previous example: Elastic Demand Elastic demand occurs when changes in price cause a disproportionately large change in quantity demanded.

For example, a good with elastic demand might see its price increase by 10, but demand falls by 30 as a result.

Goods that experience this kind of demand are labeled as price-sensitive, and are typically non-essential goods that have many substitutes (such as restaurant meals, fashion items, etc.).

A good is considered to be elastic when its PED is greater than 1.

For example, if the quantity demanded of a handbag falls from 300 to 200 when a price increases from 500 to 550, the handbags PED would be: The PED of the good is 4.2, which is considered to be elastic.

A good with perfectly elastic demand would have a PED of infinity, where even minuscule changes in price would cause an infinitesimally large change in demand.

Inelastic Demand Inelastic demand occurs when changes in price cause a disproportionately small change in quantity demanded.

For example, a good with inelastic demand might see its price increase by 30, but demand falls by only 10 as a result.

Goods that experience this kind of demand are labeled as being price-insensitive, and are typically essential goods that consumers have no substitutes for (such as water, medication, cigarettes, etc.).

For example, if the quantity demanded of a cancer treatment drug drops from 900 to 700 when a price increases from 500 to 900, the drugs PED would be: The PED of the good is 0.4375, which is considered to be inelastic.

A good with perfectly inelastic demand would have a PED of 0, where even huge changes in price would cause no change in demand.

Unit Elastic Demand Unit elastic demand occurs when changes in price cause an equally proportional change in quantity demanded.

Price Elasticity Of Demand Formula