Formula to Calculate Price Elasticity of Demand

The formula of Price elasticityFormula Of Price ElasticityPrice elasticity is calculated by dividing the percentage change in quantity by percentage change in price. Price elasticity typically refers to price elasticity of demand that measures the response of demand of a particular item to the change in its price. read more of demand is the measure of elasticity of demand based on price, which is calculated by dividing the percentage change in quantity (∆Q/Q) by percentage change in price (∆P/P) which is represented mathematically as

Price Elasticity of Demand = Percentage Change in Quantity (∆q/q) / Percentage Change in Price (∆p/p)

Further, the equation for price elasticity of demand can be elaborated into

Price Elasticity of Demand = [(Q1 – Q0) / (Q1 + Q0)] / [(P1 – P0)/(P1 + P0)]

Where Q0 = Initial quantity, Q1 = Final quantity, P0 = Initial price and P1 = Final price

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Price Elasticity of Demand Calculation (Step by Step)

Examples

Example #1

Let us take the simple example of gasoline. Now let us assume that a surge of 60% in gasoline price resulted in a decline in the purchase of gasoline by 15%. Using the formula as mentioned above, the calculation of price elasticity of demand can be done as:

  • Identify P0 and Q0, which are the initial price and quantity respectively, and then decide on the target quantity and, based on that, the final price point, which is termed as Q1 and P1, respectively. Now work out the numerator of the formula, which represents the percentage change in quantity. It is arrived at by dividing the difference of final and initial quantities (Q1 – Q0) by summation of the final and initial quantities (Q1 + Q0), i.e. (Q1 – Q0) / (Q1 + Q0). Now work out the denominator of the formula, which represents the percentage change in price. It is arrived at by dividing the difference of final and initial prices (P1 – P0) by summation of the final and initial prices (P1 + P0), i.e. (P1 – P0) / (P1 + P0). Finally, the price elasticity of demand is calculated by dividing the expression in Step 2 by expression in Step 3, as shown below.

  • Price Elasticity of Demand = Percentage change in quantity / Percentage change in pricePrice Elasticity of Demand = -15% ÷ 60%Price Elasticity of Demand = -1/4 or -0.25

Example #2

Let us assume that there is a company that supplies vending machines. 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 to 5,000 bottles. Now, the calculation of price elasticity of demand can be done as below:

Given, Q0 = 4,000 bottles, Q1 = 5,000 bottles, P0 = $3.50 and P1 = $2.50

Therefore,

  • Price Elasticity of Demand = (5,000 – 4,000) / (5,000 + 4,000) ÷ ($2.50 – $3.50) / ($2.50 + $3.50)Price Elasticity of Demand = (1 / 9) ÷ (-1 / 6)Price Elasticity of Demand = -2/3 or -0.667

Example #3

Now let us take the case of a beef sale in the US in 2014. Due to certain food shortages, the prices of cattle surged. In January 2014, a family of four consumed around 10.0 lbs of beef at a price pointPrice PointA price point (PP) is a selling price that a manufacturer or retailer recommends for its product or service to remain competitive in the market while also making a profit.read more of $3.47/lb. Due to the price surge, the price went up to $4.45/lb by the end of October 2014, bringing the consumption down to 8.5 lbs. Now, the calculation of the price elasticity of demand can be done as below:

Given, Q0 = 10.0 lbs, Q1 = 8.5 lbs, P0 = $3.47 and P1 = $4.45

  • Price Elasticity of Demand = (8.5 – 10.0) / (8.5 + 10.0) ÷ ($4.45 – $3.47) / ($4.45 + $3.47)Price Elasticity of Demand = (-0.081) ÷ (0.124)Price Elasticity of Demand = -0.653

Price Elasticity of Demand Calculator

You can use the following price elasticity of demand calculator.

Relevance and Use

It is of paramount importance for a business to understand the concept and relevance of price elasticity of demand to understand the relationship between the price of a good and the corresponding demand at that price. Price elasticity of demand can decide the pricing policy for different markets and various products or services.

If the quantity demanded fluctuates a lot when prices vary a little, then the product is said to be elastic. It often happens in the case of products or services with many alternatives, and, as such, the consumers are relatively price sensitivePrice SensitivePrice Sensitivity, also known and calculated by Price Elasticity of Demand, is a measure of change (in percentage term) in the demand of the product or service compared to the changes in the price. It is used widely in the business world to decide the pricing of a product or study consumer behavior.read more. In such a scenario, the business will be careful in setting the price or target a different market where the fluctuation is low.

If the quantity demanded changes by a very small margin despite a significant change in prices, then the product is inelastic. It happens when there is a lack of good substitutes for the product or service, and as such, the consumers are willing to buy at relatively higher prices. A business will price the product much more comfortably in such a market condition.

Price Elasticity of Demand in Excel (with excel template)

Now let us take the case mentioned in price elasticity of demand example #3 to illustrate the same in the excel template below. The table gives a snapshot of the monthly variation in price and consumption of a family of four for January 2014 to October 2014 and calculates the monthly price elasticity of demand.

In the below given excel template, we have used the price elasticity of demand formula to find the Monthly Price Elasticity of Demand.

So the Calculation of Monthly Price Elasticity of Demand will be-

Price Elasticity of Demand Formula Video

This has been a guide to the Price Elasticity of Demand Formula. Here, we learn how to calculate demand’s price elasticity and the practical examples and calculator with a downloadable excel template. You can learn more about Economics from the following articles –

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