Price elasticity of demand

% Change in Demand / % Change in Price.

Quite obviously this allows Price Elasticity of Demand to be easily worked out. For example, if a good increases in price by 50% but demand only falls by 25%, then Price Elasticity of Demand would be (-25%/+50%) = -0.5.

Note that this value is negative; all "Normal" goods in economic terms will have a Price Elasticity of Demand that is negative, and hence often the negative sign is missed off; therefore, the Price Elasticity of Demand for Coffee may be shown as 2.5, when in fact it really means -2.5 (this would signify that a fall/rise in price of 1 would result in an rise/fall in demand respectively of 2.5).

This idea has substantial economic consequences.

An inelastic price elasticity of demand (often shortened to PE of D, or even PED) suggests that price can be raised and revenue will increase. This occurs because demand will not fall proportionately to a price increase even though people will be paying a higher price. Petrol or gasolineis a commonly given example of a good with inelastic PE of D. This is why the government can slap heavy taxes on it without affecting how much we use our cars.

An elastic price elasticity of demand suggests that price can be cut and revenue may increase, depending on the cost of producing each item. This occurs because demand will rise greater than proportionately to the cut in price. The best example of an "elastic good" is one with lots of substitutes - Pepsi Cola is the best example. If Pepsi cut the price of a can of coke by 50% they may experience a 150% increase in demand, not by generating new customers, but by "stealing" customers of Coca-cola. Other goods with elastic PE of D include commodities like Tea - if coffee is ten times cheaper, wouldn't you be tempted?

Concept in economics that relates to the sensitivity towards a change in price.

There are two extremes of elasticity: perfectly elastic and perfectly inelastic.

The demand curve for perfectly inelastic:

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                        Q

At the other extreme, the demand curve for perfectly elastic:

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The way to determine elasticity is using the Elasticity Formula:

              percentage change in quantity demanded
     Ed =  --------------------------------------------
                    percentage change in price

If: 
    Ed > 1 , then elastic
    Ed < 1 , then inelastic
    Ed = 1 , then unitary

There are also elements that help determine elasticity:

     1.  Number of Substitutes:
               few = inelastic
               many = elastic
     2.  Necessity vs. Luxury
               necessity = inelastic
               luxury = elastic
     3.  Portion of Income:
               large portion = elastic
               small portion = inelastic
     4.  Length of "Time" that the product has been profitable:
               short = inelastic
               long = elastic