Question

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

Short answer

The Price Elasticity of Demand (PED) measures the responsiveness of the quantity demanded of a good or service to its price change. It is calculated using the formula: \(PED = \frac{%\Delta QD}{%\Delta P}\), where %\Delta QD% represents the percentage change in quantity demanded and %\Delta P% represents the percentage change in price. Depending on the PED value, we can determine if the demand is elastic, unitary elastic, inelastic, perfectly inelastic, or for a Giffen or Inferior Good. This information helps businesses make informed pricing decisions and understand the effect of price changes on consumer buying behavior.

Step-by-step solution

Definition of Price Elasticity of Demand

Price elasticity of demand is a measure of how much the quantity demanded of a good or service changes in response to a change in its price. It helps businesses and policymakers to understand the effects of price changes on the purchase behavior of consumers, which can be useful when considering pricing strategy or taxation policy.

Formula for Price Elasticity of Demand

Price Elasticity of Demand can be calculated using the following formula: \[PED = \frac{%\Delta QD}{%\Delta P}\] PED: Price Elasticity of Demand %\Delta QD%: Percentage change in the Quantity Demanded %\Delta P%: Percentage change in the Price In other words, PED is the ratio of the percentage change in quantity demanded to the percentage change in price.

Calculating Percentage Change

To calculate the percentage change in quantity demanded (%\Delta QD%) and the percentage change in price (%\Delta P%), we can use the following formulas: %\Delta QD% = \(\frac{QD_{New} - QD_{Old}}{QD_{Old}} \times 100\) %\Delta P% = \(\frac{P_{New} - P_{Old}}{P_{Old}} \times 100\) QD_Old: Initial Quantity Demanded QD_New: New Quantity Demanded P_Old: Initial Price P_New: New Price These formulas give us the percentage changes in quantity demanded and price, which we can then use to calculate the PED using the main formula mentioned earlier.

Interpreting the Value of Price Elasticity of Demand

The value of the Price Elasticity of Demand (PED) can help interpret the sensitivity of the quantity demanded to price changes. Here are some possible values of PED and their interpretations: 1. PED > 1: Elastic Demand (The quantity demanded is sensitive to price changes) 2. PED = 1: Unitary Elastic Demand (The quantity demanded changes at the same proportion as the price) 3. 0 < PED < 1: Inelastic Demand (The quantity demanded is less sensitive to price changes) 4. PED = 0: Perfectly Inelastic Demand (The quantity demanded does not change at all when the price changes) 5. PED is negative: Giffen Good or Inferior Good (As the price increases, the quantity demanded also increases) By understanding the concept and calculating the Price Elasticity of Demand, businesses can make informed pricing decisions and anticipate the impact of price changes on their revenue.