# Interpretations of Price Elasticity of Demand

## The price elasticity of demand (PED) explains how much changes in price affect changes in quantity demanded.

#### Key Points

• Elastic PED can be interpreted as consumers being very sensitive to changes in price.

• Inelastic PED can be interpreted as consumes being insensitive to changes in price.

• Firms use PED to figure out how to change their prices in order to increase revenue.

• PED varies along a straight demand curve.

#### Terms

• The percent change in quantity demanded due to a 1% change in price.

#### Figures

1. ##### Elasticity and the Demand Curve

The price elasticity of demand for a good has different values at different points on the demand curve.

2. ##### Perfectly Elastic Demand

Perfectly elastic demand is represented graphically by a horizontal line. In this case the PED value is the same at every point of the demand curve.

3. ##### Perfectly Inelastic Demand

Perfectly inelastic demand is graphed as a vertical line. The PED value is the same at every point of the demand curve.

The price elasticity of demand (PED) is a measure of the responsiveness of the quantity demanded of a good to a change in its price. It can be calculated from the following formula:

$\frac{\%Change \; in \; Quantity \; Demanded}{\%Change \; in \; Price}$

When PED is greater than one, demand is elastic. This can be interpreted as consumers being very sensitive to changes in price: a 1% increase in price will lead to a drop in quantity demanded of more than 1%.

When PED is less than one, demand is inelastic. This can be interpreted as consumers being insensitive to changes in price: a 1% increase in price will lead to a drop in quantity demanded of less than 1%.

he effect of price changes on total revenue PED may be important for businesses attempting to distinguish how to maximize revenue For example, if a business finds out its PED is very inelastic, it may want to raise its prices because it knows that it can sell its products for a higher price without losing many sales. Conversely, if a business finds that its PED is very elastic, it may wish to lower its prices. This would allow the business to dramatically increase the number of units sold without losing much revenue per unit.

There are two notable cases of PED. The first is when demand is perfectly elastic. Perfectly elastic demand is represented graphically as a horizontal line (Figure 2). In this case, any increase in price will lead to zero units demanded.

The second is perfectly inelastic demand. Perfectly inelastic demand is graphed as a vertical line (Figure 3) and indicates a price elasticity of zero at every point of the curve. This means that the same quantity will be demanded regardless of the price.

Since PED is measured based on percent changes in price, the nominal price and quantity mean that demand curves have different elasticities at different points along the curve. Elasticity along a straight line demand curve varies from zero at the quantity axis to infinity at the price axis (Figure 1). Below the midpoint of a straight line demand curve, elasticity is less than one and the firm wants to raise price to increase total revenue. Above the midpoint, elasticity is greater than one and the firm wants to lower price to increase total revenue. At the midpoint, E1, elasticity is equal to one, or unit elastic.

#### Key Term Glossary

consumer
An individual who trades money for goods.
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demand
The desire to purchase goods and services.
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demand curve
The graph depicting the relationship between the price of a certain commodity and the amount of it that consumers are willing and able to purchase at that given price.
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elastic
Sensitive to changes in price.
##### Appears in these related concepts:
Elastic
Demand for a good is elastic when a change in price has a relatively large effect on the quantity of the good demanded.
##### Appears in these related concepts:
elasticities
Elasticity is the ratio of the percentage change in one variable to the percentage change in another variable. It is a tool for measuring the responsiveness of a function to changes in parameters in a unitless way.
##### Appears in these related concepts:
elasticity
The sensitivity of changes in a quantity with respect to changes in another quantity.
firm
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goods
That which is produced, then traded, bought, or sold, and finally consumed.
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inelastic
Not sensitive to changes in price.
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Inelastic
Demand for a good is inelastic when a change in price has a relatively small effect on the quantity of the good demanded.
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nominal
Without adjustment to remove the effects of inflation (in contrast to real).
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perfectly elastic
A type of goods such that infinitesimally small changes in price cause infinitely large changes in quantity supplied.
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Perfectly elastic
Describes a situation when any increase in the price, no matter how small, will cause demand for a good to drop to zero.
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perfectly inelastic
An elasticity equal to zero; the elasticity of a type of goods for which quantity supplied does not change regardless of the price of the goods.
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price
The cost required to gain possession of something.
##### Appears in these related concepts:
Price
The quantity of payment or compensation given by one party to another in return for goods or services.
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price elasticity
A measure of how a product's demand and supply will change if you adjust its price.
##### Appears in these related concepts:
revenue
The total income received from a given source.
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total revenue
The profit from each item multiplied by the number of items sold.
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Unit Elastic
Demand for a good is unit elastic when the percentage change in quantity demanded is equal to the percentage change in price.