Elasticity of Demand

Elasticity of Demand is defined as E(d) = proportionate change in quantity demanded/proportionate change in price. This means that the quantity demanded decreases when the price increases. Mathematically, we can find the price elasticity of demand by using the following equations: Q2 -Q1 (Q1 + Q2)/2 P2 - P1 (P1 + P2)/2 where: Q1 = Initial quantity Q2 = Final quantity P1 = Initial price P2 = Final price. When the quantity demanded is elastic, the change in price causes more of a change in the quantity demanded. When quantity demanded is inelastic, the change in price causes less of a change in quantity demanded. If the product has a unitary elasticity, the small changes in price does not affect total revenue. There are factors that affect the price elasticity of demand: 1. Availability of substitutes: if there are more possible substitutes, there is a greater elasticity. 2. Degree of necessity or luxury: these will usually have a greater elasticity because products that have a low degree of necessity can be habit forming when consumers think of them as "necessities." 3. Proportion of purchaser's budget consumed by the item: these tend to consume a large portion of the purchaser's budget and has a greater elasticity. 4. Time period considered: these are greater over the long run because consumers will adjust their behavior. 5. Permanent or temporary price change: one-day sale has a different outcome than a permanent price decrease. 6. Price points: when the price decreases from $2.00 to $1.99 gets a greater outcome than decreasing it from $1.99 to $1.98. Resources www.quickmba.com/econ/micro/elas/ped.shtml