Meaning of price elasticity of demand
The price elasticity of demand is a pure number. The law of demand tells us that if price of a commodity goes up, quantity demanded of the commodity falls. But often the more relevant question is “by how much?” That is what the price elasticity number tries to answer for you. The price elasticity of demand denotes the degree of responsiveness of the quantity demanded of good X to change in its price Px. In other words, the price elasticity number (E) simply tells you that if price goes up by a certain percent, by what percentage does quantity demanded responds to it? The way we define price elasticity of demand is as follows
 .......................................(1) Or, if we are given the initial (with subscript 1) and changed level (with subscript 2) of prices and quantities,
 . ......................................................(2)
Examples |
Example 1: Suppose the price elasticity of demand for gasoline is = .4 and the price of gas increased by 22%. How is the quantity demanded expected to change?
Answer: We can derive the answer from the above definition (1):
Quantity demanded is expected to decrease by (.4 ) (22) = 8.8% |
Example 2: Let us suppose that price of apples decreased from $23 a bushel to $21 a bushel and quantity demanded increased from 30 bushel to 50 bushels. What is the price elasticity of demand?
Answer: Here we are given the initial and changed prices and so we use equation (2). Remember price elasticity of demand is a pure number, so we ignore sign and take the absolute number.
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Classification: Elastic, Inelastic and Unitary Elastic
a. Price Inelastic Demand
For some commodities, a small increase in price will change quantity demanded in a very small amount. You can think of commodities that are necessities (example, heating services of homes in winter, air-travel for business passengers) or commodities on which we spend very small amount of income (like salt – a container of salt cost 40cents). These commodities will have low price-elasticity of demand meaning that a small change in price will have relatively little impact on the quantity demanded. In case of a price increase by 5% there is a fall in quantity demanded by less than proportionate amount that is, less than 5%, we call it inelastic demand. Here, E <1. When E< 1, this is a case of inelastic demand.
b. Price Elastic Demand
On the other hand there are commodities for which a small change in price will drastically reduce the amount of the commodity demanded. For example, air-travel for vacationers is very sensitive to price. A rise in the air fare will lead the vacationer to choose another mode of transportation like car or lead him to postpone the vacation plan for the time being. Thus for a rise in air fare for the vacationers we will see a relatively more drastic reduction in quantity demanded and hence high price elasticity of demand. In case a price increase by 5% leads to a fall in quantity demanded by more than proportionate amount, that is, more than 5%, we call it elastic demand. Here, E>1. When E>1, this is a case of elastic demand. c. Unitary Elastic Demand
For some commodities price increase will bring about proportionate change in quantity demanded. For example, a 5% rise in price will bring a 5% decrease in quantity demanded. This is a case of unitary price elasticity. Here, E =1. When E = 1, this is a case of unitary elastic demand.
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