Price elasticity of demand is the measure of how demand of a product changes in response to changes in price. It indicates the degree of change in quantity demanded of a good in response to a change in price of the good.
If demand of a product increases after a price increase, the demand of the product is elastic. If demand of a product decreases after a price increase, the demand of the product is inelastic. Thus, price elasticity of demand helps us understand the change in quantity demanded of a good and how it impacts revenue generation by a firm. In this blog, we will discuss what price elasticity of demand is and how you can calculate it using
midpoint method.
What is Price Elasticity of Demand?
- price elasticity of demand is a measure of the responsiveness of demand to changes in price.
In economics,
price elasticity of demand (PED) measures how the demand for a good or service changes with a change in its price. In general, price elasticity of demand is negative, meaning that the quantity demanded of a good or service decreases as its price increases. There are two types of price elasticity of demand—elastic demand and inelastic demand.
An elastic demand is characterized by a decrease in the percentage of a good demanded as its price increases. For example, a change in price causes a smaller percentage change in total revenue earned on the item. An inelastic demand is characterized by an increase in the percentage of a good demanded as its price increases. For example, a change in price causes larger percentage change in total revenue earned on the item. Knowing the elasticity of a product is valuable for determining pricing strategies.
The Formula of Price Elasticity of Demand
The formula of price elasticity of demand is a mathematical formula used to estimate the percentage change in quantity demanded of a product as the percentage change in price.
Consider a demand curve, with price on the vertical axis and quantity on the horizontal axis. The elasticity of demand is calculated by dividing the percentage change in quantity demanded by the percentage change in price. To understand this formula better, let us consider a demand curve of a hypothetical product with price of $10 per unit and elasticity of demand of -2%. This would mean that a change of 2% in quantity demanded leads to a change of -2% in price demanded.
Price Elasticity of Supply
The price elasticity of supply is a measure of how the quantity supplied of a good or service changes in response to a change in its price. In general, price elasticity of supply is positive, meaning that the quantity supplied of a good or service increases as its price increases. There are two types of price elasticities of supply—elastic supply and inelastic demand.
Elasticity Formula
In order to calculate the percentage change in quantity demanded (Qd) we use this formula:
%ΔQd=(%ΔP/P)*Eq%
Arc Elasticity Formula
The
arc elasticity formula of a demand curve is calculated by dividing the percentage change in quantity demanded by the percentage change in price.
The arc elasticity formula for elasticity of demand is as follows:
%ΔQd=(%ΔP/P)*(1+Ed)
where, Qd = quantity demanded and P = price.
What is the Midpoint Method?
The midpoint method is a formula in economics used to calculate price elasticity of demand. It is a modified price elasticity formula that measures the relationship between price and product demand.
The midpoint formula modifies the original price elasticity calculation to measure the change in quantity demanded when a percentage change in price is implemented. The formula for the midpoint method is as follows:
E(D) = {[(Q2- Q1 ) / (Q2+ Q1 ) / 2]} / {[(P2- P1 ) / (P2+ P1 ) / 2]}.
The Formula of Midpoint Method for Price Elasticity of Demand Calculator
When analyzing price elasticity of demand, the midpoint method is a common formula that economists use. This formula is a simple way of calculating elasticity, and it can be seen in the context of demand curves.
The midpoint of a demand curve is the price point where quantity demanded reaches a 50 percent change in quantity demanded (also known as the elasticity of demand). The value of elasticity used in a price elasticity of demand formula can be negative or positive, but it always results in a negative number. In other words, the quantity demanded will change by half of the percentage change in price.
The midpoint formula of price elasticity of demand follows this format: [(Q2- Q1 ) / (Q2+ Q1 ) / 2] / [(P2- P1 ) / (P2+ P1 ) / 2]. This value always produces a negative number as the quantity and price adjust in opposite directions. It shows how elastic demand is affected by price change, so it's helpful when analyzing price elasticity of demand.
Example of Price Elasticity of Demand Calculated Using the Midpoint Method
Price elasticity of demand is a measure of the responsiveness of demand to a change in price. It indicates the percentage change in quantity demanded of a good following a change in price.
Usually, price elasticity of demand is calculated using the midpoint method. This method takes the average of two values and is represented by the formula: Q2-Q1) / [(Q2+Q1)/2]. The midpoint formula for price elasticity of demand is: (Q2 - Q1) / [(Q2 + Q1) / 2]/ (P2 - P1).
The midpoint formula is easy to calculate because it reflects the average percentage change in price and quantity. However, it doesn't take into account the value of 'change' in price. This can result in a higher or lower value than what would be obtained by taking the average of two values.
The midpoint method also doesn't properly reflect absolute changes in quantity demanded.
The midpoint method is simple but there are various other formulations that can be used to estimate price elasticity of demand more accurately.
Conclusion
The price elasticity of demand, in simple terms, is a measure of responsiveness of demand for a particular good or service to a change in price. By estimating the price elasticity of demand, businesses can better understand how price changes will affect demand for a given product or service and make informed decisions about price changes.
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