Understanding Price Elasticity of Demand
Price elasticity of demand is defined as the relative percent change of quantity demanded to a relative percent change in the price of a commodity, while holding other demand determinants constant. It is calculated using the formula, Er= dQ/Q/dP/P. Demand for a product is termed as elastic when its price elasticity (Er) is greater than one. The demand for a product is inelastic when its price elasticity is less than one. Unitary elastic demand is the percentage change in price of a product yields a proportional percentage change in quantity demanded. This makes the price elasticity of demand to be one (Ayers & Collinge, 2003).
In the illustration, the price per gallon of paint is $3 and increases to $3.50 while the demand for paint in gallons drops from 35 gallons to 20 gallons. Drop in change in quantity demanded is 10 gallons of paint. Change in price is $0.50. The price elasticity of demand for paint is calculated as, Er= dQ/Q/dP/P*100
The price elasticity of demand for paint is 3.4. The negative sign shows the inverse proportion between price and quantity demanded. This indicates that it is elastic meaning that a percentage change in price of paint yields a greater than proportionate percentage change in quantity of paint demanded. The price elasticity is more than one thus elastic demand for paint (Griffiths, & Wall, 2008).
This result means that any change in price of paint yields a more than proportional change in quantity of paint demanded. It is evident as a $0.5 increase in price results in a 10-gallons drop in quantity of paint bought, as well as, 3.4 elasticity in price. There is a high probability that any increase in price of paint would lead to further decrease in paint demanded.