MBA
Economics and Management Decisions
1. Price Elasticity of Demand
The vending machines sell soft drinks at $3.50 per bottle. Now at this price, consumers buy 4,000 bottles
per week. To increase sales, it has been decided to decrease the price to $2.50, increasing sales to5,000
bottles. Now, calculate the price elasticity of demand.
1.1.
Definition of Price Elasticity
Price Elasticity of demand (Ed) explains the responsiveness of the quantity demanded of a
commodity to the corresponding changes in its price.
1.2.
Type of Price Elasticity
1.
2.
3.
4.
5.
1.2.1.
Perfect Elastic Demand
Perfect Inelastic Demand
Relatively Elastic Demand
Relatively Inelastic Demand
Unitary Elastic Demand
Perfect Elastic Demand
There is a greater change in demand in response to a percentage or smaller change in the
price. For example, with a little change in the price of a commodity, its demand decreases or
completely stops and vice versa
1.2.2.
Perfect Inelastic Demand
Consumers do not respond to a product with an increase or a decrease in its price. This means
that despite the change in prices, demand remains the same.
1.2.3.
Relatively Elastic Demand
When the percentage change in the demand for a product is significantly higher than the
corresponding change in its price, consumers tend to switch to cheaper alternatives.
1.2.4.
Relatively Inelastic Demand
The percentage change in the demand for a product is less than the percentage change
in its price.
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MBA
Economics and Management Decisions
1.2.5.
Unitary Elastic Demand
The corresponding change in the demand and price of a product is the same
1.3.
Price Elasticity
Elasticity of demand= % change in quantity demanded / % change in price.
Ep=
Where as
𝛥𝑄 is Q2-Q1
𝛥𝑃 is P2-P1
P, P1= Initial Price
Q, Q1= Initial quantity demand
P2= New Price
Q1=New quantity demand
In our case
Price
P1=3.5
P2=2.5
Quantity
Q1=4000
Q2=5000
𝜟𝑸
= 5000-1000
i.e 1000
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=2.5-3.5 =
i.e -1.0
25%
𝐸𝑝 =
Ep= - 0.875
Change in
Demand
𝜟𝑷
1000
3⋅5
×
−1.0
4000
= 0.25
Change in Price
=
.
.
28.6%
= - 0.286
MBA
Economics and Management Decisions
1.4.
Conclusion
Percentage change in the demand (25%) for a given product is less that the percentage change in price
(28.6%) and estimated Ep is <1, this shows that given product has impact of relatively Inelastic
Demand.
The minus sign shows the inverse relationship between Price and Quantity demand.
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