How to Calculate Price Elasticity of Demand

Price elasticity aids business decisions.

Price elasticity of demand is the relationship between a change in price and the corresponding change in quantity. It tells you how sensitive the quantity demanded is to a change in price. Businesses look at this very closely because it helps them in their pricing decisions. It also helps in evaluating how much business may be gained or lost when prices are raised or lowered.

Instructions

1. Take a typical demand curve and select two points on it. For example, Point A has a price of $15 and a quantity demanded of 15. Point B has a price of $10 and a quantity demanded of 18.

2. Calculate the percentage change in quantity. With two points on the demand curve, take the change in quantity and then divide it by the beginning quantity.

   Take ( Q2 - Q1 ) / Q1.

   In the example, Q2 = 18 and Q1 = 15. So the difference between them is 3. Dividing this by 15 gives you a 20 percent. In other words, quantity demanded increased by 20 percent.

3. Calculate the percentage change in price. Take the difference between the two prices and divide it by the beginning price.

   The formula is ( P2 - P1 ) / P1.

   Referring back to the example, P2 = $10 and P1 = $15. So the difference between them is $5. Dividing this by 15 gives you a -33 percent. In other words, price decreased by 33 percent.

4. Divide the percentage change in quantity by the percentage change in price. This gives you the price elasticity of demand. In the example, divide the 20 percent increase in quantity by the 33 percent decrease in price.That gives you a price elasticity of demand of -60 percent or -0.60.

Tips & Warnings

• Elastic demand means a small change in price results in a larger change in quantity.

• Inelastic demand means a small change in price results in a smaller change in quantity.

• Unit elasticity means a small change in price results in an equal change in quantity.

References

• NetMBA: Price Elasticity of Demand