The Price Elasticity
of Demand
The price elasticity of demand measures the
responsiveness of changes in quantity demanded due to a percentage change
in price. A high price elasticity indicates that the percentage change
in quantity varies by a large amount due to a small change in price.
A low price elasticity indicates that the percentage change in quantity
varies by a small amount due to a change in price. Price elasticity
of demand is normally designated as EQd,P which should be read
as the elasticity of the quantity demanded with respect to a change
in price. In general, elasticities are abbreviated Ex,y
where x is the variable we want to measure the change in and y is the variable
causing the change in x. Mathematically this can be written as:
Which can be abbreviated as %DQd/%DP,
where D is the change in. Both of these
percentages are written in absolute values. The reason economists
do this is because, mathematically, the ratio is negative. But elasticity
measures the responsiveness of quantity demanded to a change in price.
This means that an elasticity of -5 indicates a 5% fall in the quantity
demanded due to a 1% increase in price. A -2 indicates a 2% decrease
in quantity due to a 1% increase in price. Since a 5% decrease in
quantity is larger than a 2% decrease in quantity -5 is a larger elasticity
than -2. But mathematically -2 is a larger number than -5.
To avoid the unusual position of explaining how a larger number is smaller
we simply take the absolute value. Before continuing we will look
at an example of the price elasticity of demand.
Example: If a 10% increase in the price of candy causes the
quantity demanded of candy to fall by 15%, what is the price elasticity
of demand?
The fall in the quantity demanded of candy is 15% we put this
number into the numerator (top). The rise in the price of candy is
10% we put this into the denominator (bottom).
So 15%/10% = 1.5. The price elasticity of demand for candy
is 1.5.
This should be read as a 1% rise in the price of candy will cause
the quantity demanded of candy to fall by 1.5%.
