Price elasticity of demand: Indicates consumer response to price change. It measured as the
percentage change in quantity demanded, divided by the percentage change in price. It is
better to use percentage change because the measure is unit free, this way the goods of
varying prices may be compared.
Elasticity decreases from high to low prices. Except when
1. The demand curve is horizontal where a quantity changes results from a 0 percentage
change in price. (Elasticity is infinite)
2. The demand curve is vertical where no quantity results from the change in price.
(Elasticity has a 0 value)
1. Omit the negative sign when writing the elasticity.
2. The higher the absolute value of elasticity, the higher the sensitivity (high prices).
3. At high prices elasticity is high; at low prices elasticity is low.
4. Elasticity is not constant.
Price elasticity of demand = Percentage change in the quantity demanded = %ΔQ
Percentage change in price %ΔP
%ΔQ = ΔQ/(Average)Q = ΔQ x p
%ΔP ΔP/(Average)P ΔP Q
(responsiveness of quantity demanded to change in price)
Arc elasticity: is used to define consumer responsiveness over a segment or arc of the demand
Point elasticity: Is the elasticity computed at a particular point on the demand curve.
When the demand curve intersects the horizontal axis, it has an elasticity value of 0.
The closer to the intersection on the vertical axis, the more the elasticity value tends to
Elastic: When the price elasticity is greater than unity
Unit elastic: If the value is exactly 1
Inelastic: the value lies between 0 and 1
Determinates of price elasticity:
Tastes: When a good or service is a basic necessity in one’s life, then the price variations have
a minimal effect on purchase.
Ease of substitution: Alternatives goods or services for the product in question. If a supplier
convinces consumer that its product is unique, it will create a less elastic demand. It can then
increase prices and generates more revenue.
Product groups: If a manufacture of product x reduces its price, buyers would be expected to
substitute towards this product in large numbers. Manufacturer of this brand would find
demand highly responsive. But, if all producers of brand x reduce their price, the increase in
demand for any one will be more muted.
Price elasticity and total expenditure At high prices existing sales are low, and the impact of decreasing the price is outweighed by
the increase in sales following the decrease in price. ; Therefore the net impact on total
expenditure of a price reduction is positive. (Revenue increases in response to price declines
at high prices) This occurs when demand is elastic
When existing sales are high if you decrease prices to gain sales, the loss on a price margin is
more significant than the extra revenue that is generated by additional sales. The net effect is
that total expenditure falls. (Revenue decreases in response to price decreases at low
prices) This occurs when demand is inelastic
At the midpoint of the curve where the composite effect of price changes just offset each
other, no change in revenue results from a change in price. (In order to maximize the possible
revenue from a sale of a good or service, it should be priced where the demand elasticity is
unit elastic). This occurs when demand is Unit elastic
Short run and long run elasticity
The price elasticity of demand is frequently lower