Question

Define price elasticity of demand. Please indicate how you (the administrator) would use the information from an investigation paid by your company according to which the absolute price elasticity of demand for your product is 0.5 and not 1.1 as previously thought. In other words, would you recommend raising the prices of your product so that your company earns more income? Explain.

Answer 1

Price elasticity of demand is the measure of responsiveness of change in demand to change in prices.

The formual to calculate elasticity of demand(denoted by e) is e= percentage change in demand/percentage change in prices.

If | e|> 1 , it implies that in response to a percentage change in prices, demand changes by more than a percent or demand is elastic to the change in prices.

If |e| <1, implies that in response to a percentage change in prices, demand changes by less than a percentage or demand is inelastic.

|e| = 1 implies that demand changes equally in response to change in price.

Here , the administrator had thought |e| >1 , which means she thought that if she increases price by1% , then demand would decrese by 1.1%. she has thought that demand of her product is price elastic, and if she tries to increase the price of products, demand would fall even more than the increase in price.

But now she knows that |e| < 1 , which means the demand for product is price inelastic, if she changes prices by 1% , demand would only decrease by 0.5% . Hence she can plan to set the price level higher or increase the price of her product , which would lessen the demand only by a small margin , thus increasing the overall profit or firm's income