Published Sep 8, 2024 Price elasticity refers to the degree to which the quantity demanded or supplied of a good or service changes in response to a change in its price. It quantifies the sensitivity of consumers or producers to price changes. More specifically, price elasticity of demand measures the responsiveness of the quantity demanded to price changes, while price elasticity of supply measures the responsiveness of the quantity supplied to price changes. Similarly, price elasticity of supply can also be categorized as elastic, inelastic, or unitary, based on the responsiveness of quantity supplied to price changes. Consider the market for luxury cars. If the price of a luxury car increases by 10% and the demand decreases by 20%, this indicates an elastic demand because the quantity demanded changes significantly with a price increase. Using the formula for elasticity: An elasticity of -2 indicates that the luxury car demand is highly responsive to changes in price (elastic). Price elasticity is vital for businesses, consumers, and policymakers for several reasons: Several factors influence the price elasticity of demand, including: Businesses use price elasticity to make informed decisions regarding pricing, marketing, and production. By understanding the elasticity of their products, they can set prices that maximize revenue and profit. For example, if a product is found to have elastic demand, a business may choose to lower prices during a sale to increase volume sold. Conversely, for inelastic products, the firm might safely increase prices to boost revenue without worrying about significant drops in sales. Additionally, knowledge of elasticity helps businesses in budgeting and forecasting, aiding in efficient allocation of resources and better strategic planning. Yes, price elasticity for a given product can change over time due to various factors such as changes in consumer preferences, emergence of new substitutes, changes in income levels, and technological advancements. For instance, as technology evolves, the price elasticity of demand for certain electronic gadgets might increase because consumers have more alternatives to choose from. Similarly, as consumer incomes rise, the demand for luxury goods might become less elastic as these goods transition from being considered luxuries to necessities for higher-income groups. Understanding these shifts allows businesses to adapt their strategies to effectively respond to market dynamics and consumer behavior changes.Definition of Price Elasticity
Example
Elasticity = (% Change in Quantity Demanded) / (% Change in Price)
Elasticity = ([(800 - 1000) / 1000] * 100) / ([(110,000 - 100,000) / 100,000] * 100)
Elasticity = (-20%) / (+10%)
Elasticity = -2
Why Price Elasticity Matters
Frequently Asked Questions (FAQ)
What factors influence price elasticity of demand?
How do businesses use price elasticity in their decision making?
Can price elasticity change over time for a given product?
Economics