Price Elasticity of Demand - Explained
What is Price Elasticity of Demand?
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What is Price Elasticity of Demand?
The ratio of change in the quantity of product that is demanded or the product purchased to the change in price is called as Price Elasticity of Demand. Its formula in terms of economics is as follows PED = (dQ/Q) / (dP/P) Economists use Price Elasticity to interpret how the real economy works. They get to know about how the supply or demand changes. For example, the price of some goods does not change by changing the supply or demand of those goods. So they are termed as inelastic. Let us take an example to understand inelastic goods. People want to travel or move around the world to accomplish their tasks. For this purpose, they have to buy gasoline. If the price of oil is increased, then the people will buy the amount of gas in the same quantity. Whereas if we talk about inelastic goods, then we see very noticeable changes in the price of such goods because of the demand or supply of those goods changes. Now lets consider the formula and examine how the demand side of the equation is affected by varying the price elasticity of demand. You can see the difference in the price elasticity of supply as well.
What is the Price Elasticity of Supply?
The price elasticity of supply is the percentage change in quantity supplied divided by the percentage change in price.
How is Price Elasticity of Supply and Demand Used?
If the quantity demanded shows a very noticeable change by changing the price of that quantity then it is known as elastic quantity. It means that the quantity is stretched very much from its mean position or preliminary point. Similarly, if the quantity exhibits a very small or minor change in reaction to its price, such a quantity is known as inelastic quantity. It shows that the quantity is not much fluctuated from its previous point. If the buyer substitutes one product with another product whose price is increasing very fast, the demand for the product will decrease in the same manner. Lets make it easier to understand. If the people rate coffee and tea equally, and the price of coffee increases, then it would be quite easier for people to choose tea instead of coffee. Because they like coffee and tea equally. So, they will buy tea instead of coffee, then the demand for coffee will fall automatically. This is because both are a very good replacement for each other. If you have an option either to buy a product or wait until its price goes down, then, of course, you will wait and use the old one that you already have unless the old product is damaged. For instance, if you have an old washing machine and it works perfectly but you want to buy a new one when you go to the market and check the price of a new machine. If the price is too high, you will obviously change your mind and wait until the price falls. So, the quantity will fall when its price becomes high. But if we take a look into less discretionary goods i.e. the goods in which we do not have the option to buy or not. The quantity demanded of such goods will not fall as much as it falls for the more discretionary goods. We can say, the less discretionary a good is, the less its quantity demanded will decrease. For example, the buyers pay for the privilege means they pay a large amount for a small house, or addictive products or they require add-on products. Add-on products are those which have some extra features and additional charges are applied to buy such products. It includes tobacco, alcohol and many other add-on products. Sin taxes are applied to such products. Lost tax revenues on the sold products generally increased by the higher taxes on the products still sold. Inkjet printer cartridges and college textbooks are examples of add-on products. These goods are very important to buy. They cant be forgone or neglected as they are not discretionary items. They do not have any replacement. For example, only HP printers can use HP ink. Just like demand and supply, time is also very important. Due to changes in price, demand also changes. If a product is sold on a certain price, its demand response is variable. It may change as the season changes.
Examples of Price Elasticity of Demand
It is commonly a rule of thumb that if the quantity of an item demanded or bought fluctuates more than the variations in the price, then the item or product is considered elastic. (The price is increased by +five percent, but the demand is decreased by -ten percent. On the other hand, if the quantity of an item demanded or bought is the same as the price of that item then it is considered as Unit elasticity.(ten percent/ ten percent is equal to one). If the quantity bought or demanded changes lower than its price, it is said to as inelastic (-five percent demanded a +ten percent variation in price). Lets calculate the elasticity of demand. Let the price of an apple is decreased by 6 percent from USD 1.99 a bushel to USD 1.87 a bushel. Then you see that the customers or purchasers will purchase more apples. Their purchase is increased by 20 percent. Elasticity of apples = 0.20/0.06 = 3.33 In terms of demand, it shows that the apples are elastic.
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