What is price elasticity of demand?
How is price elasticity of demand calculated?
How is price elasticity of demand represented in a graph?
How is price elasticity of demand used in management to make pricing decisions?
Find out Below:
Price Elasticity of Demand
Price elasticity of demand is the degree of responsiveness of the quantity demanded of a product as a result of a unit change in its own price (Case and Fair, 1999). Price elastic products are those whose demand change significantly with a change in prices of that commodity. Products with inelastic demand do not change its demand even if its prices change.
Price Elasticity of Demand Formula
Arc elasticity can be calculated using the formula below.
Where Ed = Elasticity of demand, P1 = Price of the product at point 1, P2 = Price at point 2, Qd1 and Qd2 are quantities demanded at points 1 and 2 respectively.
The results can be interpreted by determining whether the price elasticity, Ed is equal to 0, equal to, less than, or greater than 1, or less than 1 but greater than 0. If Ed = 0, then the demand is perfectly inelastic (figure 2). If 0 < Ed < 1, then the demand is inelastic. If Ed = 1, then demand is unitarily elastic. If 1 < Ed < ∞ then the demand is elastic (Case and Fair, 1999). If Ed = ∞ then the demand is perfectly elastic (figure 3).
Using Price Elasticity of Demand in Management Decisions
As a manager, when I know the price elasticity of demand I will decide whether to raise the prices or not. If the product has a perfectly inelastic demand, I will raise the prices significantly because the change in prices will not affect demand. If the elasticity of demand is perfectly elastic, I will not change the product prices because a slight change in prices will cause significant change in demand of the product. If the demand is relatively inelastic, I will increase the prices slightly because it will cause a slight change in demand. One of the examples from my experience is the sale of electronics which were in a competitive market. When I raised the prices, a few people came into my shop until I head to reduce the prices again. These were relatively elastic demand products.