Price Elasticity of Demand Calculation

Overview

This lecture covers calculating the price elasticity of demand with a step-by-step example, explains the interpretation of results, and highlights common pitfalls in calculation and understanding.

Example: Calculating Price Elasticity of Demand

• At $5, quantity demanded is 25 boxes; at $6, demand falls to 15 boxes.
• Identify initial price (P₁ = $5), new price (P₂ = $6), initial quantity (Q₁ = 25), and new quantity (Q₂ = 15).
• Use the midpoint formula for percentage changes: [(Q₂−Q₁) / ((Q₂+Q₁)/2)] × 100 for quantity; [(P₂−P₁) / ((P₂+P₁)/2)] × 100 for price.
• Percentage change in quantity: (15−25) / 20 × 100 = −50%.
• Percentage change in price: (6−5) / 5.5 × 100 ≈ 18.2%.
• Price elasticity of demand = % change in quantity / % change in price = (−50) / 18.2 ≈ −2.75.

Interpreting Elasticity Results

• Elasticity is commonly reported as a positive value (absolute value), but keeping the negative sign clarifies direction of change.
• Price elasticity of demand is usually negative due to the inverse relationship between price and quantity demanded.
• Elasticity greater than 1 (|elasticity| > 1) indicates elastic demand; consumers are highly responsive to price changes.
• Do not convert elasticity into a percentage; it is a ratio, not a percentage.

Key Terms & Definitions

• Price Elasticity of Demand — The ratio of the percentage change in quantity demanded to the percentage change in price.
• Midpoint Formula — Calculates percentage change using averages of initial and new values to avoid bias.
• Elastic Demand — When the absolute value of elasticity is greater than 1; demand responds significantly to price changes.
• Absolute Value — The positive value of a number regardless of sign, used to compare magnitudes.

Action Items / Next Steps

• Practice solving a similar elasticity problem on your own before watching the next example.