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INCOME STATEMENT: A statement of the revenues, expenditures, and profit for a business, household, or government entity over a given period of time. An income statement also goes by the names profit and loss statement, earnings report, and operating statement. This is one of two key financial statements for an entity. The other is a balance sheet, which is a statement of assets, liabilities, and net worth at a given point in time.

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PRICE ELASTICITY OF DEMAND:

The relative response of a change in quantity demanded to a change in price. More specifically the price elasticity of demand is the percentage change in quantity demanded due to a percentage change in price. This notion of elasticity captures the demand side of the market. A comparable elasticity on the supply side is the price elasticity of supply. Other notable demand elasticities are income elasticity of demand and cross elasticity of demand.
The price elasticity of demand reflects the law of demand relation between price and quantity. An elastic demand means that the quantity demanded is relatively responsive to changes in price. An inelastic demand means that the quantity demanded is not very responsive to changes in price.

Suppose, for example, that the price of hot fudge sundaes increases by 10 percent (say $2.00 to $2.20). The higher price is bound to cause the quantity demanded to decline. The price elasticity of demand answers the question: How much? If the quantity demanded decreases by more than 10 percent (say from 100 hot fudge sundaes to 50 hot fudge sundaes), then demand is elastic. If the quantity demanded decreases by less than 10 percent (say from 100 hot fudge sundaes to 99 hot fudge sundaes), then demand is inelastic.

A Summary Formula

The price elasticity of demand is often summarized by this handy formula:
price elasticity
of demand
=percentage change
in quantity demanded
percentage change
in price
According to the law of demand, higher demand prices are related to smaller quantities demanded. As such, the numerator and denominator of this formula always have opposite signs--if one is positive, the other is negative. If the demand price increases and the percentage change in price is positive, then the quantity demanded decreases and the percentage change in quantity demanded is negative. When calculated, the price elasticity of demand, therefore, is always negative.

However, it is often convenient to ignore the negative sign when evaluating the relative response of quantity demanded to price. For example, quantity demanded is very responsive to price if a 10 percent increase in price induces a 50 percent decrease in quantity demanded. This generates a large "negative number," which is actually a small "value." To avoid the possible confusion over a big number being a small value, the negative value of the price elasticity of demand is generally ignored and focus is placed on the absolute magnitude of the number itself.

A Range of Elasticity

AlternativeCoefficient (E)
Perfectly ElasticE = ∞
Relatively Elastic1 < E < ∞
Unit ElasticE = 1
Relatively Inelastic0 < E < 1
Perfectly InelasticE = 0
The price elasticity of demand is commonly divided into one of five elasticity alternatives--perfectly elastic, relatively elastic, unit elastic, relatively inelastic, and perfectly inelastic--depending on the relative response of quantity to price. These five alternatives form a continuum of possibilities.

The chart to the right displays the five alternatives based on the coefficient of elasticity (E). The negative value obtained when calculating the price elasticity of demand is ignored.

  • Perfectly Elastic: The top of the chart begins with perfectly elastic, given by E = ∞. Perfectly elastic means an infinitesimally small change in price results in an infinitely large change in quantity demanded.

  • Relatively Elastic: The second category is relatively elastic, in which the coefficient of elasticity falls in the range 1 < E < ∞. With relatively elastic demand, relatively small changes in price cause relatively large changes in quantity. Quantity is very responsive to price. The percentage change in quantity is greater than the percentage change in price. Here a 10 percent change in price leads to more than a 10 percent change in quantity demanded (maybe something 20 percent).

  • Unit Elastic: The third category is unit elastic, in which the coefficient of elasticity is E = 1. In this case, any change in price is matched by an equal relative change in quantity. The percentage change in quantity is equal to the percentage change in price. For example, a 10 percent change in price induces a equal 10 percent change in quantity demanded. Unit elastic is essentially a dividing line or boundary between the elastic and inelastic ranges.

  • Relatively Inelastic: The fourth category is relatively inelastic, in which the coefficient of elasticity falls in the range 0 < E < 1. With relatively inelastic demand, relatively large changes in price cause relatively small changes in quantity. Quantity is not very responsive to price. The percentage change in quantity is less than the percentage change in price. In this case, a 10 percent change in price induces less than a 10 percent change in quantity demanded (perhaps only 5 percent).

  • Perfectly Inelastic: The final category presented in this chart is perfectly inelastic, given by E = 0. Perfectly inelastic means that quantity demanded is unaffected by any change in price. The quantity is essentially fixed. It does not matter how much price changes, quantity does not budge.

Slope and Elasticity

The price elasticity of demand is related to, but different from, the slope of the demand curve. Consider the formula for calculating the slope of the demand curve.
slope=change
in price
change
in quantity demanded
Now consider the formula for calculating the price elasticity of demand.
price elasticity
of demand
=percentage change
in quantity demanded
percentage change
in price
The key differences between these are:
  • First, price is in the numerator and quantity is in the denominator for slope. In contrast, quantity is in the numerator and price is in the denominator for elasticity. At the very least, slope is the inverse of elasticity. When one is bigger the other is smaller.

  • Second, slope is calculated using the measurement units for price and quantity. In contrast, elasticity is calculated using percentage changes. As such, slope includes the measurement units (such as dollars per hot fudge sundae), whereas elasticity is just a number with no measurement units. The value of slope changes if the measurement units change (such as cents versus dollars). Not so for elasticity. Elasticity is in relative values not absolute measurement units.

Three Determinants

Three factors that affect the numerical value of the price elasticity of demand are the availability of substitutes, time period of analysis, and proportion of budget. A given good can have a different price elasticity of demand if these determinants change.
  • Availability of Substitutes: The ease with which buyers can find substitutes-in-consumption affects the price elasticity of demand. The general rule is that goods with a greater availability of substitutes is more sensitive to price changes. With more substitutes available, buyers can easily respond to price changes. Consider, for example, Auntie Noodles Frozen Macaroni Dinner, an enjoyable, nutritious, and satisfying meal. Unfortunately for the Auntie Noodles company, it is one of thousands of comparable food products on the market. The number of available substitutes makes the price elasticity of demand extremely elastic.

  • Time Period of Analysis: The longer the time period of analysis, the more responsive quantities are to price changes. Brief periods do not allow buyers the time needed to adjust their consumption decisions to price changes. Buyers need time to find substitutes-in-consumption. Longer time periods allow buyers the time needed to find alternatives. For example, the demand for 4M Cable Television is not very elastic. Given the lack of close substitutes, buyers continue to buy even though prices rise, especially for brief periods like a few months. However, given enough time (years? decades?) buyers are able to seek out alternatives such as satellite dishes, and thus change their quantity demanded of cable television, resulting in a more elastic demand.

  • Proportion Of Budget: The price elasticity of demand depends on the proportion of the budget that buyers devote to a good. The rule is this: The larger the portion, the more responsive quantity demanded is to price changes. A house, for example, is a BIG budget item for most normal human beings. A relatively small change, say 1 percent on a $100,000 house, can make a BIG difference in the buyer's decision to buy. As such, relatively small changes in price are likely to induce relatively large changes in quantity demanded.

Three Other Elasticities

The price elasticity of demand is one of four common elasticities used in the analysis of the market. The other three are price elasticity of supply, income elasticity of demand, and cross elasticity of demand.
  • Price Elasticity of Supply: On the other side of the market is the price elasticity of supply. This is the relative response of quantity supplied to changes in the price. It is also analogously specified as the percentage change in quantity supplied to a percentage change in price.

  • Income Elasticity of Demand: This is the relative response of demand to changes in income, or the percentage change in demand due to a percentage change in income. This elasticity quantifies the buyers' income demand determinant.

  • Cross Elasticity of Demand: This is the relative response of demand to changes in the price of another good, or the percentage change in the demand for one good due to a percentage change in the price of the other good. This elasticity quantifies the other prices demand determinant.

<= PRICE DISCRIMINATIONPRICE ELASTICITY OF SUPPLY =>


Recommended Citation:

PRICE ELASTICITY OF DEMAND, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2014. [Accessed: September 17, 2014].


Check Out These Related Terms...

     | elasticity | elastic | inelastic | price elasticity of supply | income elasticity of demand | cross elasticity of demand | coefficient of elasticity | elasticity alternatives | elasticity determinants |


Or For A Little Background...

     | market | price | quantity | demand | law of demand | demand curve | determinants | cause and effect | variables |


And For Further Study...

     | elasticity and demand slope | elasticity and supply intercept | demand elasticity and total expenditure | buyers' income, demand determinant | other prices demand determinant | utility and demand | consumer demand theory |


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