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How to Determine the Price Elasticity of Demand - dummies

Ed approaches 0, demand is perfectly inelastic. Consumers are very insensitive to price change. Ed is usually greater in the higher price range than in lower price range. Demand is more elastic in upper left portion of the demand curve than in the lower right portion of the curve. However, it is impossible to judge elasticity of a demand curve by its flatness or steepness. Along a linear demand curve, its elasticity changes. This relationship is demonstrated in the following example:. Definition: Law of demand tells us that consumers will respond to a price drop by buying more, but it does not tell us how much more.

But, we focus on the magnitude of the the change by neglecting the minus sign and use absolute value Examples: 1. The degree of response of quantity demanded to a change in price can vary considerably.

Interpretations of Price Elasticity of Demand

The key benchmark for measuring elasticity is whether the co-efficient is greater or less than proportionate. PED on a linear demand curve will fall continuously as the curve slopes downwards, moving from left to right. Consider these figures and calculate Total, Marginal and Average Revenue. Marginal revenue MR , which is defined as the revenue from selling one extra unit. This is calculated by finding the change in TR from selling one more unit.

Study the patterns of numbers and see if you can analyse the relationships between the three measures of revenue — then answer the following:.

Price Elasticity of Demand

There are several reasons why firms gather information about the PED of its products. A firm will know much more about its internal operations and product costs than it will about its external environment. Therefore, gathering data on how consumers respond to changes in price can help reduce risk and uncertainly.

Calculating Price, Income, and Cross Price Elasticities

More specifically, knowledge of PED can help the firm forecast its sales and set its price. The firm can forecast the impact of a change in price on its sales volume, and sales revenue total revenue, TR. Knowing PED helps the firm decide whether to raise or lower price, or whether to price discriminate. Price discrimination is a policy of charging consumers different prices for the same product.

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If demand is elastic, revenue is gained by reducing price, but if demand is inelastic, revenue is gained by raising price. When PED is highly elastic, the firm can use advertising and other promotional techniques to reduce elasticity. There are several reasons why consumers may respond elastically or inelastically to a price change, including:. Consumers are also relatively insensitive to changes in the price of habitually demanded products. PED will vary according to where the product is in its life cycle.

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When new products are launched, there are often very few competitors and PED is relatively inelastic.