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Price elasticity of demand

Price elasticity of demand(PEDor Ed) is a measure used in economics to show the responsiveness, or elasticity,of the quantitydemanded of a good or service to a change in its price. More precisely, it gives the percentage change in quantity demanded in

response to a one percent change in price (ceteris paribus,i.e. holding constant all the other determinants of demand, such as

income). It was devised byAlfred Marshall.

Price elasticities are almost always negative, although analysts tend to ignore the sign even though this can lead to ambiguity.

Only goods which do not conform to thelaw of demand,have a positive PED. In general, the demand for a good is said to

be inelastic(or relatively inelastic) when the PED is less than one (in absolute value): that is, changes in price have a relatively

small effect on the quantity of the good demanded.

DefinitionIt is a measure of responsiveness of the quantity of a good or service demanded to changes in its price .[1]The formula for the

coefficient of price elasticity of demand for a good is:

Two alternative elasticity measures avoid or minimise these shortcomings of the basic elasticity formula:point-price

elasticityand arc elasticity.

Point price elasticityOne way to avoid the accuracy problem described above is to minimise the difference between the starting and ending prices

and quantities. This is the approach taken in the definition ofpoint-priceelasticity, which usesdifferential calculus to calculate

the elasticity for an infinitesimal change in price and quantity at any given point on the demand curve:[14]

Arc elasticityA second solution to the asymmetry problem of having a PED dependent on which of the two given points on a demand curve is

chosen as the "original" point and which as the "new" one is to compute the percentage change in P and Q relative to

the averageof the two prices and the averageof the two quantities, rather than just the change relative to one point or the

other.

This method for computing the price elasticity is also known as the "midpoints formula", because the average price and average

quantity are the coordinates of the midpoint of the straight line between the two given points

Determinants

The overriding factor in determining PED is the willingness and ability of consumers after a price change to postpone

immediate consumption decisions concerning the good and to search for substitutes ("wait and look") .[24]A number of factors

can thus affect the elasticity of demand for a good:[25]

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Availability ofsubstitute goods Breadth of definition of a good: Percentage of income: Duration: Brand loyalty: Who pays:

Interpreting values of price elasticity coefficients

Perfectly inelastic demand[10] Perfectly elastic demand[10]

Elasticities of demand are interpreted as follows:[10]

Value Descriptive Terms

Perfectly inelastic demand

Inelastic or relatively inelastic demand

Unit elastic, unit elasticity, unitary elasticity, or unitarily

elastic demand

Elastic or relatively elastic demand

Perfectly elastic demand

The concept of elasticity is simply the slope relationship of two variables expressed in

percentage terms. Price elasticity is an important determinant of the price firms will charge for

their product. When demand is price elastic, lowering price will increase total revenue; andwhen demand is inelastic, lowering price will decrease total revenue.

Price elasticity of demand is calculated as the ratio of the relative change in quantity demanded to therelative change in price. Mathematically, price elasticity of demand is just the percent change in quantity

demanded divided by the percent change in price. In this way, price elasticity of demand answers the

question "what would be the percent change in quantity demanded in response to a 1 percent increase in

price?" Notice that, because price and quantity demanded tend to move in opposite directions, price

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elasticity of demand usually ends up being a negative number. To make things simpler, economists will

often represent price elasticity of demand as an absolute value. (In other words, price elasticity of demand

could just be represented by the positive part of the elasticity number, eg. 3 rather than -3.) Conceptually,

you can think of elasticity as an economic analogue to the literal concept of elasticity- in this analogy, the

change in price is the force applied to a rubber band, and the change in quantity demanded is how much the

rubber band stretches. If the rubber band is very elastic, the rubber band will stretch a lot, and it it's very

inelastic, it won't stretch very much, and the same can be said for elastic and inelastic demand.

The Slope of the Demand CurveThedemand curve is drawn with price on the vertical axis and quantity demanded (either by an individual or

by an entire market) on the horizontal axis. Mathematically, the slope of a curve is represented by rise over

run, or the change in the variable on the vertical axis divided by the change in the variable on the horizontal

axis. Therefore, the slope of the demand curve represents change in price divided by change in quantity, and

it can be thought of as answering the question "by how much does an item's price need to change for

customers to demand one more unit of it?"

Elasticity,on the other hand, aims to quantify the responsiveness of demand and supply to changes in price,

income, or otherdeterminants of demand.Therefore, price elasticity of demand answers the question "by

how much does the quantity demanded of an item change in response to a change in price?" The calculation

for this requires changes in quantity to be divided by changes in price rather than the other way around.

Price Elasticity of Supply and the Slope of the Supply CurveUsing similar logic, the price elasticity of supply is equal to the reciprocal of the slope of the supply curve

times the ratio of price to quantity supplied. In this case, however, there is no complication regarding

arithmetic sign, since both the slope of the supply curve and the price elasticity of supply are greater than or

equal to zero.

Other elasticities, such as the income elasticity of demand, don't have straightforward relationships with the

slopes of the supply and demand curves. If one were to graph the relationship between price and income

(with price on the vertical axis and income on the horizontal axis), however, an analogous relationship

would exist between the income elasticity of demand and the slope of that graph.

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