In this note, we are going to know about the Price Elasticity of Demand, Types of Price Elasticity of Demand, and Importance of Price Elasticity of Demand. Welcome to Poly Notes Hub, a leading destination for Diploma Engineering Note.
Author Name: Arun Paul.
What is the Price Elasticity of Demand?
Price elasticity of demand (PED) is a term used in economics to describe the responsiveness or sensitivity of the quantity requested of an item or service to variations in price. It is computed as the percentage change in quantity demanded divided by the percentage change in price. It is also defined as the ratio of the % Change in Quantity Demanded to the % Change in Price.
The formula for price elasticity of demand (PED) is:
PED = (% Change in Quantity Demanded / % Change in Price)
Where,
- % Change in Quantity Demanded: The term “%ΔQD” refers to the percentage change in quantity demanded owing to a change in price, provided all other parameters stay constant.
%ΔQD = { ( New Quantity Demanded – Old Quantity Demanded ) / Old Quantity Demanded } x 100 %
- % Change in Price: The percent change in price, often denoted as “%ΔP,” represents the percentage change in the price of a good or service.
%ΔP = { ( New Price – Old Price ) / Old Price } x 100 %
Types of Price Elasticity of Demand
There are several types of PEDs –
- Elastic Demand: If the percentage change in quantity demanded exceeds the percentage change in price, the PED is more than one, indicating that demand is relatively sensitive to price changes.
- Inelastic Demand: If the percentage change in quantity demanded is smaller than the percentage change in price, PED is less than one, showing that price changes have little effect on demand.
- Unitary Elasticity: If the percentage change in quantity requested is exactly equal to the percentage change in price, PED equals one.
Importance of Price Elasticity of Demand
- Business Decision-Making: Understanding the PED allows organizations to make more educated pricing decisions. For example, if demand for a product is elastic, lowering the price may result in a proportionally higher rise in the quantity desired, thereby increasing overall revenue.
- Government Policy: Governments utilize the PED to plan and assess economic policies like taxation and subsidies. Taxes on inelastic commodities can be applied without significantly reducing consumption, whereas taxes on elastic items may drastically reduce consumption.
- Customer Behavior Analysis: Studying demand price elasticity improves understanding of consumer behavior and preferences. Products with elastic demand are typically more sensitive to price fluctuations, indicating that consumers are more likely to seek alternatives when prices shift.