Question

What is price elasticity of demand?

Hint:

Price elasticity of demand helps businesses and policymakers understand how changes in price will affect consumer behavior and overall revenue.

Answer 1

Price elasticity of demand (PED) measures the responsiveness of the quantity demanded of a good or service to a change in its price. It is defined as the percentage change in quantity demanded divided by the percentage change in price. Mathematically, it can be represented as: \[ \text{Price Elasticity of Demand (PED)} = \frac{\text{\% change in quantity demanded}}{\text{\% change in price}} \] The significance of price elasticity lies in understanding how changes in price affect total revenue and demand. There are several types of price elasticity:

Step 1: Types of Price Elasticity.
- Elastic Demand (PED>1): When the percentage change in quantity demanded is greater than the percentage change in price. Consumers are highly responsive to price changes. For example, luxury goods often have elastic demand.
- Inelastic Demand (PED<1): When the percentage change in quantity demanded is less than the percentage change in price. Consumers are less responsive to price changes. Examples include basic necessities like salt or bread.
- Unitary Elastic Demand (PED = 1): When the percentage change in quantity demanded is exactly equal to the percentage change in price. In this case, total revenue remains unchanged.

Step 2: Factors Affecting Price Elasticity.
Several factors influence the price elasticity of demand, such as: - Availability of Substitutes: If substitutes are readily available, demand is more elastic.
- Necessity vs. Luxury: Necessities tend to have inelastic demand, while luxuries are more elastic.
- Time Period: Over time, demand tends to become more elastic as consumers find alternatives.
- Proportion of Income Spent: If a good takes up a large portion of a consumer's income, its demand is more elastic.