Price elasticity of demand

Price elasticity of demand (PED or Ed) is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price when nothing but the price changes. More precisely, it gives the percentage change in quantity demanded in response to a one percent change in price. Price elasticity of demand (PED or Ed) is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price when nothing but the price changes. More precisely, it gives the percentage change in quantity demanded in response to a one percent change in price. Price elasticities are almost always negative, although analysts tend to ignore the sign even though this can lead to ambiguity. Only goods which do not conform to the law of demand, such as Veblen and Giffen goods, have a positive PED. In general, the demand for a good is said to be inelastic (or relatively inelastic) when the PED is less than one (in absolute value): that is, changes in price have a relatively small effect on the quantity of the good demanded. The demand for a good is said to be elastic (or relatively elastic) when its PED is greater than one. Revenue is maximised when price is set so that the PED is exactly one. The PED of a good can also be used to predict the incidence (or 'burden') of a tax on that good. Various research methods are used to determine price elasticity, including test markets, analysis of historical sales data and conjoint analysis. Price elasticity of demand further divided intoPerfectly Elastic Demand (∞)Perfectly Inelastic Demand ( 0 )Relatively Elastic Demand (> 1) Relatively Inelastic Demand (< 1) Unitary Elasticity Demand (= 1) The variation in demand in response to a variation in price is called price elasticity of demand. It may also be defined as the ratio of the percentage change in demand to the percentage change in price of particular commodity. The formula for the coefficient of price elasticity of demand for a good is: where P is the price of the demanded good and Q is the quantity of the demanded good. The above formula usually yields a negative value, due to the inverse nature of the relationship between price and quantity demanded, as described by the 'law of demand'. For example, if the price increases by 5% and quantity demanded decreases by 5%, then the elasticity at the initial price and quantity = −5%/5% = −1. The only classes of goods which have a PED of greater than 0 are Veblen and Giffen goods. Although the PED is negative for the vast majority of goods and services, economists often refer to price elasticity of demand as a positive value (i.e., in absolute value terms). This measure of elasticity is sometimes referred to as the own-price elasticity of demand for a good, i.e., the elasticity of demand with respect to the good's own price, in order to distinguish it from the elasticity of demand for that good with respect to the change in the price of some other good, i.e., a complementary or substitute good. The latter type of elasticity measure is called a cross-price elasticity of demand. As the difference between the two prices or quantities increases, the accuracy of the PED given by the formula above decreases for a combination of two reasons. First, the PED for a good is not necessarily constant; as explained below, PED can vary at different points along the demand curve, due to its percentage nature. Elasticity is not the same thing as the slope of the demand curve, which is dependent on the units used for both price and quantity. Second, percentage changes are not symmetric; instead, the percentage change between any two values depends on which one is chosen as the starting value and which as the ending value. For example, if quantity demanded increases from 10 units to 15 units, the percentage change is 50%, i.e., (15 − 10) ÷ 10 (converted to a percentage). But if quantity demanded decreases from 15 units to 10 units, the percentage change is −33.3%, i.e., (10 − 15) ÷ 15. Two alternative elasticity measures avoid or minimise these shortcomings of the basic elasticity formula: point-price elasticity and arc elasticity.