Price Elasticity of Demand

Price Elasticity of Demand

• Price elasticity of demand is elastic above the mid-point of the demand curve and inelastic below the mid-point.
• The price elasticity of demand is calculated using the formula: (change in quantity demanded / average quantity) / (change in price / average price).
• If the price falls from 25to25 to 25to15, the quantity demanded increases from 0 to 20 pizzas an hour, and the price elasticity of demand is 4.

Elasticity and Total Revenue

• The total revenue from the sale of a good or service equals the price of the good multiplied by the quantity sold.
• If demand is elastic, a 1% price cut increases the quantity sold by more than 1%, and total revenue increases.
• If demand is inelastic, a 1% price cut increases the quantity sold by less than 1%, and total revenue decreases.
• If demand is unit elastic, a 1% price cut increases the quantity sold by 1%, and total revenue remains unchanged.
• The total revenue test is a method of estimating the price elasticity of demand by observing the change in total revenue that results from a price change.

Examples of Elasticity and Total Revenue

• If the price of a pizza falls from 25to25 to 25to12.50, the quantity demanded increases from 0 to 25 pizzas an hour, demand is elastic, and total revenue increases.
• At $12.50 a pizza, demand is unit elastic, and total revenue stops increasing.
• At 25 pizzas an hour, demand is unit elastic, and total revenue is at its maximum.
• If the price of a pizza falls from $12.50 to zero, the quantity demanded increases from 25 to 50 pizzas an hour, demand is inelastic, and total revenue decreases.

Your Expenditure and Elasticity

• If your demand is elastic, a 1% price cut increases the quantity you buy by more than 1%, and your expenditure on the item increases.
• The price elasticity of demand is a units-free measure of the responsiveness of the quantity demanded of a good to a change in its price.

Calculating Price Elasticity of Demand

• To calculate the price elasticity of demand, express the change in price as a percentage of the average price, and express the change in the quantity demanded as a percentage of the average quantity demanded.
• The average price and average quantity demanded are the averages of the initial and new price and quantity, respectively.

Example of Calculating Price Elasticity of Demand

• Initially, the price of a pizza is $20.50 and the quantity demanded is 9 pizzas an hour.
• The price of a pizza falls to $19.50 and the quantity demanded increases to 11 pizzas an hour.
• The average price is $20, and the average quantity demanded is 10 pizzas an hour.
• The percentage change in quantity demanded is 20%, and the percentage change in price is 5%.
• The price elasticity of demand is 4 (20% / 5%).