Price elasticity of demand

A measure of the responsiveness of the quantity demanded of a good to a change in its price. The greater the extent to which demand falls as price rises, the greater the price elasticity of demand.

Price elasticity = % Δ Qd / % ΔP
Where:
% Δ = change in value/ average value

Interpretations:
Price elasticity in absolute value
If ∞
Perfectly inelastic, any change in price do not affect the quantity demanded. The demand curve is in vertical.

If greater than 1
Elastic, a small change in price accompanied by a large change in quantity demanded.

If smaller than 1
Inelastic, a large change in price accompanied by a small change in quantity demande

If =0
Perfectly elastic, a small rise in price reduce the quantity demanded to zero. The demand curve is in horizontal


Notes:

• The price elasticity of demand faced by an individual firm is higher than that faced by the entire industry.
• The price elasticity of demand tends to increase in the long run.
• Slope of demand curve is not equal to the elasticity (higher pice is more elastic than lower price)
• Increase in price will drecrease revenue (revenue = PxQ) for elastic goods and increase revenue for inelastic goods.

Determinants of elasticity:

• Availability of substitutes
• Share of budget spent on product (If represents a small portion, it is more inelastic)
• Effect of time (less elastic in short run and more elastic in long run)