Price Elasticity

Price Elasticity of Demand (PED): Price elasticity of demand (PED) measures how responsive the quantity demanded of a good is to changes in its price. It helps us understand how sensitive consumers are to price changes. The formula for price elasticity of demand is:
PED= %ΔQd/%ΔP
Where:
  • PED is the price elasticity of demand.
  • %ΔQd is the percentage change in quantity demanded.
  • %ΔP is the percentage change in price.
Interpretation of PED:
  • If PED > 1 (elastic), it indicates that the demand is responsive to price changes, and a price increase will lead to a proportionally larger decrease in quantity demanded, and vice versa.
  • If PED < 1 (inelastic), it suggests that the demand is not very responsive to price changes, and a price increase will result in a proportionally smaller decrease in quantity demanded, and vice versa.
  • If PED = 1 (unitary elasticity), the percentage change in quantity demanded is exactly equal to the percentage change in price.
 Income Elasticity of Demand (YED): Income elasticity of demand (YED) measures how the quantity demanded of a good changes in response to changes in consumers' income. It helps us classify goods as normal or inferior. The formula for income elasticity of demand is:
YED= %ΔQd/%ΔY
Where:
  • YED is the income elasticity of demand.
  • %ΔQd is the percentage change in quantity demanded.
  • %ΔY is the percentage change in income.
Interpretation of YED:
  • If YED > 0 (positive), it indicates that the good is a normal good, meaning as income increases, the quantity demanded increases, and vice versa.
  • If YED < 0 (negative), it suggests that the good is an inferior good, meaning as income increases, the quantity demanded decreases, and vice versa.
  • If YED = 0, the good is income inelastic, meaning changes in income have little to no impact on the quantity demanded.
 Cross-Price Elasticity of Demand (XED): Cross-price elasticity of demand (XED) measures how the quantity demanded of one good changes in response to changes in the price of another good. It helps us understand if goods are substitutes or complements. The formula for cross-price elasticity of demand is:
XED= %ΔQd(A) / %ΔP(B)
Where:
  • XED is the cross-price elasticity of demand between good A and good B.
  • %ΔQd(A) is the percentage change in the quantity demanded of good A.
  • %ΔP(B) is the percentage change in the price of good B.
Interpretation of XED:
  • If XED > 0 (positive), it indicates that goods A and B are substitutes, meaning as the price of good B increases, the quantity demanded of good A increases, and vice versa.
  • If XED < 0 (negative), it suggests that goods A and B are complements, meaning as the price of good B increases, the quantity demanded of good A decreases, and vice versa.
  • If XED = 0, there is no significant relationship between the two goods in terms of changes in price.