Question

What is the price elasticity of demand? Can you explain it in your own words?

Short answer

The price elasticity of demand (PED) is a measure of how sensitive the quantity demanded of a good is to a change in its price, calculated as the percentage change in quantity demanded divided by the percentage change in price. In simpler terms, it shows how strongly buyers react to a change in the price of a product or service. Depending on the value of PED, demand can be classified as elastic (sensitive to price changes), unitary (neither sensitive nor insensitive), or inelastic (insensitive to price changes).

Step-by-step solution

Defining Price Elasticity of Demand

The price elasticity of demand (PED) is a measure of how sensitive the quantity demanded of a good is to a change in its price. It is calculated as the percentage change in quantity demanded divided by the percentage change in price. The formula to calculate price elasticity of demand is: PED = \(\frac{\% \text{ change in quantity demanded}}{\% \text{ change in price}}\)

Calculating Percentage Change

To calculate percentage change for both price and quantity demanded, use the following formula: Percentage change = \(\frac{\text{New value - Old value}}{\text{Old value}} \times 100\)

Example Calculation

Let's say the price of a product increased from \(10 to \)12 and the quantity demanded decreased from 200 to 180. First, we need to calculate the percentage change in price and quantity demanded: Percentage change in price = \(\frac{12 - 10}{10} \times 100 = 20\%\) Percentage change in quantity demanded = \(\frac{180 - 200}{200} \times 100 = -10\%\) Now, use the PED formula: PED = \(\frac{-10\%}{20\%} = -0.5\)

Classification and Interpretation

Price elasticity of demand can be classified into the following categories: 1. Elastic (PED > 1): A change in price leads to a larger change in quantity demanded. The demand is sensitive to price changes. 2. Unitary (PED = 1): A change in price leads to an equal change in quantity demanded. The demand is neither very sensitive nor very insensitive to price changes. 3. Inelastic (0 < PED < 1): A change in price leads to smaller change in quantity demanded. The demand is insensitive to price changes. In our example, the PED was -0.5, which indicates that the demand for the product is inelastic. This means that the quantity demanded changes at a smaller rate than the price change.

Conclusion

Price elasticity of demand is a measure of the sensitivity of the quantity demanded to a change in price. Depending on the value of PED, we can classify the demand as elastic, unitary, or inelastic, which helps to determine the responsiveness of consumers to price changes. In everyday language, it shows us how strongly buyers react to a change in the price of a certain product or service.