Price Elasticity of Demand Formula

What Is Price Elasticity of Demand Formula?

The price elasticity of demand formula is a method used to measure the sensitivity of the change in the demand of goods and services due to change in the price of the same. It shows the relationship of price to the demand in the market.

What Is Price Elasticity of Demand Formula

It can be of different types elastic, inelastic, perfectly elastic, perfectly inelastic, and unitary elastic. It proves to be very useful to manufacturers who can use it to plan their future production and expansion projects by analyzing how any current change in price is affecting the current demand in the market.

Price Elasticity Of Demand Formula Explained

The absolute price elasticity of demand formula explains the effect of change in price on demand of goods and services. It shows the responsiveness of demand to changes in price of goods in the market and is very useful in production planning, resource allocation and future expansion.

The formula of Price elasticity of demand is the measure of elasticity of demand based on price, which is calculated by dividing the percentage change in quantity (∆Q/Q) by percentage change in price (∆P/P) which is represented mathematically as

Price Elasticity of Demand = Percentage Change in Quantity (∆q/q) / Percentage Change in Price (∆p/p)

Further, the equation for price elasticity of demand can be elaborated into

Price Elasticity of Demand = /

Where Q0 = Initial quantity, Q1 = Final quantity, P0 = Initial price and P1 = Final price

The result of the economics price elasticity of demand formula is a numerical value that is interpreted to understand the elasticity. If the value is greater than one, the product is said to be elastic, a value of less than one denotes inelastic, and a value of one indicates that the elasticity is unitary, in which the percentage change in demand is same as the percentage change in the price.

If the quantity demanded fluctuates a lot when prices vary a little, then the product is said to be elastic. It often happens in the case of products or services with many alternatives, and, as such, the consumers are relatively price sensitive. In such a scenario, the business will be careful in setting the price or target a different market with low fluctuation.

If the quantity demanded changes by a very small margin despite a significant change in prices, then the product is inelastic. It happens when there is a lack of good substitutes for the product or service, and as such, the consumers are willing to buy at relatively higher prices. A business will price the product much more comfortably in such a market condition.

How To Calculate?

The economics price elasticity of demand formula can be determined in the following four steps:

Price Elasticity of Demand

  1. Identify P0 and Q0, which are the initial price and quantity respectively, and then decide on the target quantity and, based on that, the final price point, which is termed as Q1 and P1, respectively.
  2. Now work out the numerator of the formula, which represents the percentage change in quantity. It is arrived at by dividing the difference of final and initial quantities (Q1 – Q0) by summation of the final and initial quantities (Q1 + Q0), i.e. (Q1 – Q0) / (Q1 + Q0).
  3. Now work out the denominator of the absolute price elasticity of demand formula, which represents the percentage change in price. It is arrived at by dividing the difference of final and initial prices (P1 – P0) by summation of the final and initial prices (P1 + P0), i.e. (P1 – P0) / (P1 + P0).
  4. Finally, the price elasticity of demand is calculated by dividing the expression in Step 2 by expression in Step 3, as shown below.

Examples

Let us go through some examples in details to understand the concept.

Example #1

Let us take the simple example of gasoline. Now let us assume that a surge of 60% in gasoline price resulted in a decline in the purchase of gasoline by 15%. Using the formula as mentioned above, the calculation of price elasticity of demand formula business can be done as:

Example #2

Let us assume that there is a company that supplies vending machines. The vending machines sell soft drinks at $3.50 per bottle. Now at this price, consumers buy 4,000 bottles per week. To increase sales, it has been decided to decrease the price to $2.50, increasing sales to 5,000 bottles. Now, the calculation of price elasticity of demand can be done as below:

Given, Q0 = 4,000 bottles, Q1 = 5,000 bottles, P0 = $3.50 and P1 = $2.50

Example #3

Now let us take the case of a beef sale in the US in 2014. Due to certain food shortages, the prices of cattle surged. In January 2014, a family of four consumed around 10.0 lbs of beef at a price point of $3.47/lb. Due to the price surge, the price went up to $4.45/lb by the end of October 2014, bringing the consumption down to 8.5 lbs. Now, the calculation of the price elasticity of demand formula business can be done as below:

Calculator

You can use the following price elasticity of demand calculator.

Price Elasticity of Demand in Excel (with excel template)

Now let us take the case mentioned in price elasticity of demand example #3 to illustrate the same in the excel template below. The table gives a snapshot of the monthly variation in price and consumption of a family of four for January 2014 to October 2014 and calculates the monthly price elasticity of demand.

In the below given excel template, we have used the price elasticity of demand formula to find the Monthly Price Elasticity of Demand.

Example 1

So the Calculation of Monthly Price Elasticity of Demand will be-

Example 1.1

Importance

It is of paramount importance for a business to understand the concept and relevance of price elasticity of demand to understand the relationship between the price of a good and the corresponding demand at that price.

Limitations

Let us look at some limitations of the formula.

Thus, even though it is an important tool for manufactures to make informed decisions about their business, all pros and cons should be analysed so as to get the best results form the method.

Price Elasticity of Demand Formula Video

Frequently Asked Questions (FAQs)

Which formula represents the price elasticity of demand?

The formula that represents price elasticity of demand is Price Elasticity of Demand = Percentage change in quantity / Percentage change in price.

How to calculate the price elasticity of demand?

One may calculate the price elasticity of demand using the following formula: the percentage change in quantity demand divided by the percentage change in price.

What factors influence the price elasticity of demand?

The factors that influence the price elasticity of demand are:
1.The substitutes availability
2. The good is a luxury or an essential
3. The income proportion spent on the good
4. Time has passed since the time the product price changed.

Why is the price elasticity of demand consistently negative?

The price elasticity of demand is negative because the quantity demanded declines if the product price increases, according to the law of demand theory.

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