Price Elasticity of Demand

Last time I talked about the law of demand, it tells us that consumers
will buy more of a product when its price declines and buy less when
its price increases. But how much more or less will they buy? In order
to increase revenue, whether you should increase or decrease the price
of a product? My answer was to increase price before I learned about
price elasticity, now my answer is it depends :-)



It depends on the responsiveness (or sensitivity) of consumers to a
price change, this is measured by a product's price elasticity of
demand:

For some products - for example, restaurant meals - consumers are
highly responsive to price changes, they may order other items or even
never come again if a restaurant increases the prices of some items.
The demand for such products is elastic.



For other products, for example, salt - consumers pay much less
attention to price changes, substantial price changes cause only small
changes in the amount purchased. The demand for such products is
inelastic.



So my answer would be to increase prices of the inelastic products to
increase revenue, but might think about to reduce the price of elastic
products to increase revenue by selling more products.

One example is manay stores have the buy one get one free on sale
during weekend or holiday season, you will see most of those iteams are
elastic products, the inelastic products won't be on sale most of the
time.



How to calculate the price elasticity of demand?

Ed = [(change in quantiy)/(sum of quantities)/2] / [(Change in price)/(sum of prices)/2]

For example, if  Q1 is 1, Q2 is 2, P1 is 8, P2 is 7, then Ed = [(2-1)/(1+2)/2] / [(8-7)/(8+7)/2] = 5

if Q1 is 7, Q 2 is 8, P1 is 2, P2 is 1, then Ed = 0.2



A product is elastic when its Ed is larger than 1, it's inelastic when
its Ed is less than 1, if Ed is 1, it means the price change won't
affect the demand.

Posted at 03:34PM Oct 31, 2006 by byuan in Economics  |  Comments[0]