Price elasticity of demand (PED) measures how the quantity demanded of a good or service responds to a change in its price. It quantifies the sensitivity of consumers to price fluctuations, highlighting how much the quantity demanded will increase or decrease when the price changes.
The formula for calculating price elasticity of demand is:
\[ PED = \frac{%\text{ Change in Quantity Demanded}}{%\text{ Change in Price}} \]
Key Concepts
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Elastic Demand: If PED > 1, demand is considered elastic, meaning consumers are highly responsive to price changes. A small price decrease will lead to a relatively large increase in quantity demanded, and vice versa.
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Inelastic Demand: If PED < 1, demand is inelastic, indicating that consumers are less responsive to price changes. A change in price results in a smaller percentage change in quantity demanded.
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Unitary Elastic Demand: If PED = 1, demand is unitary elastic, meaning that the percentage change in quantity demanded is equal to the percentage change in price.
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Perfectly Elastic Demand: If PED is infinite, demand is perfectly elastic. Consumers will only purchase at a specific price, and any increase in price will lead to zero quantity demanded.
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Perfectly Inelastic Demand: If PED is 0, demand is perfectly inelastic. Quantity demanded remains constant regardless of price changes, typical for essential goods such as life-saving medications.
Factors Influencing Price Elasticity of Demand
- Availability of Substitutes: The more substitutes available for a good, the more elastic its demand typically is.
- Necessity vs. Luxury: Necessities tend to have inelastic demand, while luxury goods generally have elastic demand.
- Time Horizon: Demand elasticity can vary over time; it may be more inelastic in the short term and more elastic in the long term as consumers adjust their behavior.
- Proportion of Income: Goods that take up a larger portion of a consumer's income tend to have more elastic demand, while those that are less expensive often have inelastic demand.
Understanding price elasticity of demand is crucial for businesses and policymakers, as it helps inform pricing strategies, tax policies, and revenue forecasts.