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"Price elasticity" redirects here. It is not to be confused with Price elasticity
of supply.
Price elasticity of demand (PED or Ed) is a measure used in economics to show the
responsiveness, or elasticity, of the quantity demanded of a good or service to a
change in its price, ceteris paribus. More precisely, it gives the percentage
change in quantity demanded in response to a one percent change in price (ceteris
paribus).
Price elasticities are almost always negative, although analysts tend to ignore the
sign even though this can lead to ambiguity. Only goods which do not conform to the
law of demand, such as Veblen and Giffen goods, have a positive PED. In general,
the demand for a good is said to be inelastic (or relatively inelastic) when the
PED is less than one (in absolute value): that is, changes in price have a
relatively small effect on the quantity of the good demanded. The demand for a good
is said to be elastic (or relatively elastic) when its PED is greater than one (in
absolute value): that is, changes in price have a relatively large effect on the
quantity of a good demanded. Demand for a good is:
Contents [hide]
1 Definition
2 Point-price elasticity of demand
3 Arc elasticity
4 History
5 Determinants
6 Relation to marginal revenue
7 Effect on total revenue
8 Effect on tax incidence
9 Optimal pricing
9.1 Constant elasticity and optimal pricing
9.2 Non-constant elasticity and optimal pricing
9.3 Limitations of revenue-maximizing and profit-maximizing pricing strategies
10 Selected price elasticities
11 See also
12 Notes
13 References
14 External links
Definition[edit]
The variation in demand in response to a variation in price is called the price
elasticity of demand. It may also be defined as the ratio of the percentage change
in demand to the percentage change in price of particular commodity.[1] The formula
for the coefficient of price elasticity of demand for a good is:[2][3][4]
As the difference between the two prices or quantities increases, the accuracy of
the PED given by the formula above decreases for a combination of two reasons.
First, the PED for a good is not necessarily constant; as explained below, PED can
vary at different points along the demand curve, due to its percentage nature.[8]
[9] Elasticity is not the same thing as the slope of the demand curve, which is
dependent on the units used for both price and quantity.[10][11] Second, percentage
changes are not symmetric; instead, the percentage change between any two values
depends on which one is chosen as the starting value and which as the ending value.
For example, if quantity demanded increases from 10 units to 15 units, the
percentage change is 50%, i.e., (15 - 10) 10 (converted to a percentage). But if
quantity demanded decreases from 15 units to 10 units, the percentage change is
-33.3%, i.e., (10 - 15) 15.[12][13]
History[edit]
The illustration that accompanied Marshall's original definition of PED, the ratio
of PT to Pt
Together with the concept of an economic "elasticity" coefficient, Alfred Marshall
is credited with defining PED ("elasticity of demand") in his book Principles of
Economics, published in 1890.[20] He described it thus: "And we may say generally:
the elasticity (or responsiveness) of demand in a market is great or small
according as the amount demanded increases much or little for a given fall in
price, and diminishes much or little for a given rise in price".[21] He reasons
this since "the only universal law as to a person's desire for a commodity is that
it diminishes... but this diminution may be slow or rapid. If it is slow... a small
fall in price will cause a comparatively large increase in his purchases. But if it
is rapid, a small fall in price will cause only a very small increase in his
purchases. In the former case... the elasticity of his wants, we may say, is great.
In the latter case... the elasticity of his demand is small."[22] Mathematically,
the Marshallian PED was based on a point-price definition, using differential
calculus to calculate elasticities.[23]
Determinants[edit]
The overriding factor in determining PED is the willingness and ability of
consumers after a price change to postpone immediate consumption decisions
concerning the good and to search for substitutes ("wait and look").[24] A number
of factors can thus affect the elasticity of demand for a good:[25]
where
R' is the marginal revenue
P is the price
Proof:
TR = Total Revenue
90
{\displaystyle R'={\dfrac {\partial TR}{\partial Q}}={\dfrac {\partial }{\partial
Q}}(P\,Q)=P+Q\,{\dfrac {\partial P}{\partial Q}}} R'={\dfrac {\partial TR}
{\partial Q}}={\dfrac {\partial }{\partial Q}}(P\,Q)=P+Q\,{\dfrac {\partial P}
{\partial Q}}
On a graph with both a demand curve and a marginal revenue curve, demand will be
elastic at all quantities where marginal revenue is positive. Demand is unit
elastic at the quantity where marginal revenue is zero. Demand is inelastic at
every quantity where marginal revenue is negative.[32]
A set of graphs shows the relationship between demand and total revenue (TR) for a
linear demand curve. As price decreases in the elastic range, TR increases, but in
the inelastic range, TR decreases. TR is maximised at the quantity where PED = 1.
A firm considering a price change must know what effect the change in price will
have on total revenue. Revenue is simply the product of unit price times quantity:
As a result, the relationship between PED and total revenue can be described for
any good:[35][36]
When the price elasticity of demand for a good is perfectly inelastic (Ed = 0),
changes in the price do not affect the quantity demanded for the good; raising
prices will always cause total revenue to increase. Goods necessary to survival can
be classified here; a rational person will be willing to pay anything for a good if
the alternative is death. For example, a person in the desert weak and dying of
thirst would easily give all the money in his wallet, no matter how much, for a
bottle of water if he would otherwise die. His demand is not contingent on the
price.
When the price elasticity of demand for a good is relatively inelastic (-1 < Ed <
0), the percentage change in quantity demanded is smaller than that in price.
Hence, when the price is raised, the total revenue increases, and vice versa.
When the price elasticity of demand for a good is unit (or unitary) elastic (Ed =
-1), the percentage change in quantity demanded is equal to that in price, so a
change in price will not affect total revenue.
When the price elasticity of demand for a good is relatively elastic ( -? < Ed <
-1), the percentage change in quantity demanded is greater than that in price.
Hence, when the price is raised, the total revenue falls, and vice versa.
When the price elasticity of demand for a good is perfectly elastic (Ed is - ?),
any increase in the price, no matter how small, will cause the quantity demanded
for the good to drop to zero. Hence, when the price is raised, the total revenue
falls to zero. This situation is typical for goods that have their value defined by
law (such as fiat currency); if a 5 dollar bill were sold for anything more than 5
dollars, nobody would buy it, so demand is zero.
Hence, as the accompanying diagram shows, total revenue is maximized at the
combination of price and quantity demanded where the elasticity of demand is
unitary.[36]
When demand is more inelastic than supply, consumers will bear a greater proportion
of the tax burden than producers will.
Main article: tax incidence
PEDs, in combination with price elasticity of supply (PES), can be used to assess
where the incidence (or "burden") of a per-unit tax is falling or to predict where
it will fall if the tax is imposed. For example, when demand is perfectly
inelastic, by definition consumers have no alternative to purchasing the good or
service if the price increases, so the quantity demanded would remain constant.
Hence, suppliers can increase the price by the full amount of the tax, and the
consumer would end up paying the entirety. In the opposite case, when demand is
perfectly elastic, by definition consumers have an infinite ability to switch to
alternatives if the price increases, so they would stop buying the good or service
in question completelyquantity demanded would fall to zero. As a result, firms
cannot pass on any part of the tax by raising prices, so they would be forced to
pay all of it themselves.[37]
PED and PES can also have an effect on the deadweight loss associated with a tax
regime. When PED, PES or both are inelastic, the deadweight loss is lower than a
comparable scenario with higher elasticity.
Optimal pricing[edit]
Among the most common applications of price elasticity is to determine prices that
maximize revenue or profit.
Though PEDs for most demand schedules vary depending on price, they can be modeled
assuming constant elasticity.[42] Using this method, the PEDs for various
goodsintended to act as examples of the theory described aboveare as follows. For
suggestions on why these goods and services may have the PED shown, see the above
section on determinants of price elasticity.
Cigarettes (US)[43]
-0.3 to -0.6 (General)
-0.6 to -0.7 (Youth)
Alcoholic beverages (US)[44]
-0.3 or -0.7 to -0.9 as of 1972 (Beer)
-1.0 (Wine)
-1.5 (Spirits)
Airline travel (US)[45]
-0.3 (First Class)
-0.9 (Discount)
-1.5 (for Pleasure Travelers)
Livestock
-0.5 to -0.6 (Broiler Chickens)[46]
Oil (World)
-0.4
Car fuel[47]
-0.09 (Short run)
-0.31 (Long run)
Medicine (US)
-0.31 (Medical insurance)[48]
-0.03 to -0.06 (Pediatric Visits)[49]
Patents
-0.30 to -0.50[50]
Rice[51]
-0.47 (Austria)
-0.8 (Bangladesh)
-0.8 (China)
-0.25 (Japan)
-0.55 (US)
Cinema visits (US)
-0.87 (General)[48]
Live Performing Arts (Theater, etc.)
-0.4 to -0.9[52]
Transport
-0.20 (Bus travel US)[48]
-2.8 (Ford compact automobile)[53]
Cannabis (US)[54]
-0.655
Soft drinks
-0.8 to -1.0 (general)[55]
-3.8 (Coca-Cola)[56]
-4.4 (Mountain Dew)[56]
Steel
-0.2 to -0.3[57]
Telecommunications
-0.405 (Mobile)[58]
-0.434 (Broadband)[59]
Eggs
-0.1 (US: Household only)[60]
-0.35 (Canada)[61]
-0.55 (South Africa)[62]
Golf
-0.3 to -0.7[57]
See also[edit]
Arc elasticity
Cross elasticity of demand
Income elasticity of demand
Price elasticity of supply
Supply and demand
Notes[edit]
^ Jump up to: a b Png, Ivan (1989). p.57.
Jump up ^ Parkin; Powell; Matthews (2002). pp.74-5.
^ Jump up to: a b Gillespie, Andrew (2007). p.43.
^ Jump up to: a b Gwartney, Yaw Bugyei-Kyei.James D.; Stroup, Richard L.; Sobel,
Russell S. (2008). p.425.
Jump up ^ Gillespie, Andrew (2007). p.57.
Jump up ^ Ruffin; Gregory (1988). p.524.
Jump up ^ Ferguson, C.E. (1972). p.106.
Jump up ^ Ruffin; Gregory (1988). p.520
Jump up ^ McConnell; Brue (1990). p.436.
^ Jump up to: a b Parkin; Powell; Matthews (2002). p.75.
Jump up ^ McConnell; Brue (1990). p.437
^ Jump up to: a b Ruffin; Gregory (1988). pp.518-519.
^ Jump up to: a b Ferguson, C.E. (1972). pp.100-101.
Jump up ^ Sloman, John (2006). p.55.
Jump up ^ Wessels, Walter J. (2000). p. 296.
Jump up ^ Mas-Colell; Winston; Green (1995).
^ Jump up to: a b Wall, Stuart; Griffiths, Alan (2008). pp.53-54.
^ Jump up to: a b McConnell;Brue (1990). pp.434-435.
Jump up ^ Ferguson, C.E. (1972). p.101n.
Jump up ^ Taylor, John (2006). p.93.
Jump up ^ Marshall, Alfred (1890). III.IV.2.
Jump up ^ Marshall, Alfred (1890). III.IV.1.
Jump up ^ Schumpeter, Joseph Alois; Schumpeter, Elizabeth Boody (1994). p. 959.
Jump up ^ Negbennebor (2001).
^ Jump up to: a b c d Parkin; Powell; Matthews (2002). pp.77-9.
^ Jump up to: a b c d e Walbert, Mark. "Tutorial 4a". Retrieved 27 February 2010.
^ Jump up to: a b Goodwin, Nelson, Ackerman, & Weisskopf (2009).
^ Jump up to: a b Frank (2008) 118.
^ Jump up to: a b Gillespie, Andrew (2007). p.48.
^ Jump up to: a b Frank (2008) 119.
^ Jump up to: a b Png, Ivan (1999). p.62-3.
Jump up ^ Reed, Jacob (2016-05-26). "AP Microeconomics Review: Elasticity
Coefficients". APEconReview.com. Retrieved 2016-05-27.
Jump up ^ Krugman, Wells (2009). p.151.
Jump up ^ Goodwin, Nelson, Ackerman & Weisskopf (2009). p.122.
Jump up ^ Gillespie, Andrew (2002). p.51.
^ Jump up to: a b Arnold, Roger (2008). p. 385.
^ Jump up to: a b Wall, Stuart; Griffiths, Alan (2008). pp.57-58.
Jump up ^ "Pricing Tests and Price Elasticity for one product".
Jump up ^ "Pricing Tests and Price Elasticity for several products".
Jump up ^ Png, Ivan (1999). pp.79-80.
Jump up ^ Sabatelli, Lorenzo (2016-03-21). "Relationship between the Uncompensated
Price Elasticity and the Income Elasticity of Demand under Conditions of Additive
Preferences". PLOS ONE. 11 (3): e0151390. doi:10.1371/journal.pone.0151390. ISSN
1932-6203. PMC 4801373?Freely accessible. PMID 26999511.
Jump up ^ "Constant Elasticity Demand and Supply Curves (Q=A*P^c)". Retrieved 26
April 2010.
Jump up ^ Perloff, J. (2008). p.97.
Jump up ^ Chaloupka, Frank J.; Grossman, Michael; Saffer, Henry (2002); Hogarty and
Elzinga (1972) cited by Douglas (1993).
Jump up ^ Pindyck; Rubinfeld (2001). p.381.; Steven Morrison in Duetsch (1993), p.
231.
Jump up ^ Richard T. Rogers in Duetsch (1993), p.6.
Jump up ^ "Demand for gasoline is more price-inelastic than commonly thought".
Energy Economics. 34: 201207. doi:10.1016/j.eneco.2011.09.003.
^ Jump up to: a b c Samuelson; Nordhaus (2001).
Jump up ^ Goldman and Grossman (1978) cited in Feldstein (1999), p.99
Jump up ^ de Rassenfosse and van Pottelsberghe (2007, p.598; 2012, p.72)
Jump up ^ Perloff, J. (2008).
Jump up ^ Heilbrun and Gray (1993, p.94) cited in Vogel (2001)
Jump up ^ Goodwin; Nelson; Ackerman; Weissskopf (2009). p.124.
Jump up ^ Davis, A.; Nichols, M. (2013), The Price Elasticity of Marijuana Demand"
Jump up ^ Brownell, Kelly D.; Farley, Thomas; Willett, Walter C. et al. (2009).
^ Jump up to: a b Ayers; Collinge (2003). p.120.
^ Jump up to: a b Barnett and Crandall in Duetsch (1993), p.147
Jump up ^ "Valuing the Effect of Regulation on New Services in Telecommunications"
(PDF). Jerry A. Hausman. Retrieved 29 September 2016.
Jump up ^ "Price and Income Elasticity of Demand for Broadband Subscriptions: A
Cross-Sectional Model of OECD Countries" (PDF). SPC Network. Retrieved 29 September
2016.
Jump up ^ Krugman and Wells (2009) p.147.
Jump up ^ "Profile of The Canadian Egg Industry". Agriculture and Agri-Food Canada.
Archived from the original on 8 July 2011. Retrieved 9 September 2010.
Jump up ^ Cleasby, R. C. G.; Ortmann, G. F. (1991). "Demand Analysis of Eggs in
South Africa". Agrekon. 30 (1): 3436. doi:10.1080/03031853.1991.9524200.
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External links[edit]
A Lesson on Elasticity in Four Parts, Youtube, Jodi Beggs
Price Elasticity Models and Optimization
Price elasticity of demand : Practical Applications
Approx. PED of Various Products (U.S.)
Approx. PED of Various Home-Consumed Foods (U.K.)
Categories: Elasticity (economics)DemandPricing
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