How to Calculate Price Elasticity of Demand

This article will explain how to calculate the price elasticity of demand. It's written by an economics professor who really "knows his stuff." And one who'll explain everything in simple English.

Difficulty: Moderately Easy

Instructions

1. ** What is price elasticity of demand? **
   
   Before I show you how to calculate it, let me first briefly explain what it is. Simply put, 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. And in evaluating how much business may be gained or lost when prices are raised or lowered.

2. 
   Our demand curve with two points on it

   ** Our starting point **
   
   First, we need someplace to begin. So let's take a typical demand curve and select two points on it.
   
   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.

3. ** Calculate the percentage change in quantity **
   
   Now that we have 2 points on our demand curve, our next step is to calculate the percentage change in the quantity demanded. So how do we do this? Simple, take the change in quantity and then divide it by the beginning quantity.
   
   In other words, you take ( Q2 - Q1 ) / Q1.
   
   In our example, Q2 = 18 and Q1 = 15. So the difference between them is 3. Dividing this by 15 gives us a 20%. In other words, quantity demanded increased by 20%.

4. ** Calculate the percentage change in price **
   
   Now it's time for us to do exactly what we did in step 3. Except this time, we take the difference between the two prices and divide it by the beginning price.
   
   So our formula here would be ( P2 - P1 ) / P1.
   
   Referring back to our example, P2 = $10 and P1 = $15. So the difference between them is - $5. Dividing this by 15 gives us a - 33%. In other words, price decreased by 33%.

5. ** Our final step **
   
   The last thing we need to do is divide our result from step 3 by our result from step 4. In other words, divide the percentage change in quantity by the percentage change in price. This will give us our price elasticity of demand!
   
   So in our example, we would divide the 20% increase in quantity by the 33% decrease in price. And that would give us a price elasticity of demand of -60% or - 0.60.

Tips & Warnings

• Elastic demand means a small change in price will result in a larger change in quantity
• Inelastic demand means a small change in price will result in a smaller change in quantity
• Unit elasticity means a small change in price will result in an equal change in quantity