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The price elasticity of demand (PED) captures how price-sensitive consumers are for a given product or service by measuring the responsiveness of quantity demanded to changes in the good's own price. This is in contrast to measuring the responsiveness of the good's demand to a change in price for some other good (a complement or substitute), which is called the cross-price elasticity of demand. The own-price elasticity of demand is often simply called the price elasticity.
The following formula is used to calculate the own-price elasticity of demand:
The formula above usually yields a negative value because of the inverse relationship between price and quantity demanded . However, economists often disregard the negative sign and report the elasticity as an absolute value. For example, if the price of a good increases by 5 percent and the quantity demanded decreases by 5 percent, then the elasticity at the initial price and quantity is -5%/5% = -1. This number is likely to be reported simply as 1.
There are a few other important points to note about the coefficient value provided by this formula. First, the elasticity coefficient is a pure number, meaning that it does not have units of measurement associated with it. Second, the coefficient value can range from zero to negative infinity. Finally, the result provided by the formula will be accurate only when the changes in price and quantity are small. The result will be less accurate when the changes are large.
Since PED is based off of percent changes, the starting nominal quantity and price matter. At low prices and high quantities, the PED is therefore more inelastic. For example, a drop in the price of $1 from a starting price of $100 is a 1% drop, but if the starting price is $10, it is a 10% drop. Similarly, at high prices and low quantities, PED is more elastic .
When changes in price and quantity are large., When the formula for the demand function is known and when elasticity is relatively high, When the formula for the demand function is known and when elasticity is relatively low, and When changes in price and quantity are small.