Problems on Price Elasticity of Demand
The most common elasticity measurement is that of price elasticity of demand. It measures how much consumers respond in their buying decisions to a change in price. The basic formula used to determine price elasticity is
If price increases by 10% and consumers respond by decreasing purchases by 20%, the equation computes the elasticity coefficient as -2. The result is negative because an increase in price (a positive number) leads to a decrease in purchases (a negative number). Because the law of demand says it will always be negative, many economists ignore the negative sign, as we will in the following discussion.
If the price of certain goods falls from 20/- to 10/-, that causes increase in the demand from43 units to 75 units. Calculate the price elasticity of demand.
I f the values are given separately and not in the percentages, we should apply the following formula model 1
∆Q =change in the demand.(difference in demand) =43- 75= 32
∆P=change in the price.(difference in the price) =20-10 = 10
P=initial price. (first price/ old price) =20
Q=initial demand. (first demand/ old demand)= 43
Hence Price Elasticity of Demand =1.48
We should compare the above value with the price which is 1%. And its general always.
Hence 1% of the price change causes the 1.48% change in demand
Easy way to remember:
Elastic means that a change in price leads to a bigger Change in quantity demanded. Think of a rubber band, or elastic, that stretches to a bigger size than its original size. Inelastic means that a change in price leads to a smaller Change in quantity demanded. Unlike a rubber band, it does not stretch bigger.
Unit Elastic means that a change in price leads to a one-for-One change in quantity demanded. For example, a doubling of the price leads to a halving of the quantity demanded. Remember by unit, meaning single or one.