Price elasticity of demand
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In economics, the price elasticity of demand is an elasticity that measures the responsiveness of the quantity demanded of a good to its price. The formula used to calculate the coefficient of price elasticity of demand is
- <math>E_d = \frac{%\ \rm{change}\ \rm{in}\ \rm{quantity}\ \rm{demanded}\ \rm{of}\ \rm{product}\ X}{%\ \rm{change}\ \rm{in}\ \rm{price}\ \rm{of}\ \rm{product}\ X}.<math>
Price elasticity of demand is measured as the percentage change in quantity demanded that occurs in response to a percentage change in price. For example, if, in response to a 10% fall in the price of a good, the quantity demanded increases by 20%, the price elasticity of demand would be 20%/(− 10%) = −2.
- <math>\frac{0.2}{-0.1}=-2<math> price elasticity
In general, a fall in the price of a good is expected to increase the quantity demanded, so the price elasticity of demand is negative as above. Note that in the economics literature the minus sign is often omitted and the elasticity is given as an absolute value. Because both the denominator and numerator of the fraction are percent changes, price elasticities of demand are dimensionless numbers and can be compared even if the original calculations were performed using different currencies or goods.
It may be possible that quantity demanded for a good rises as its price rises, even under conventional economic assumptions of consumer rationality. Two such classes of goods are known as Giffen goods or Veblen goods.
Various research methods are used to calculate price elasticity:
- Test markets
- Analysis of historical sales data
- Conjoint analysis
Elasticity and revenue
Price_elasticity_of_demand_and_revenue.png
The elasticity of the portion of the demand curve facing a firm determines how its revenue will change in response to changes in price. Elasticities of demand with an absolute value greater than 1.0 are "elastic", and a decrease in price will be outweighed by the greater quantity of goods sold, causing revenue to increase. Elasticities of demand with an absolute value less than 1.0 are "inelastic", and the decrease in price will be not be made up for by the greater quantity of goods sold, causing revenue to decrease.