BUSINESS ECONOMICSQ. 1 A. Price Elasticity of Demand: It is the measure of the degree of response of one variable to changes in another. Thus, the price elasticity of demand for a particular good is the relative degree of responsiveness of the quantity demanded to relative changes in its price. The elasticity of demand can be generally assessed from the steepness of the slope of the demand curve in a supply-demand graph. A very steeply sloping demand curve indicates that a given percentage increase in price will cause a small percentage decrease in the quantity of the commodity (inelastic demand), while a very gently sloping demand curve shows that a given percentage increase in price will produce a large percentage decrease in the quantity (elastic demand).
Elasticity is numerically calculated by the percentage change in the dependent variable (quantity demanded) divided by the associated percentage change in the independent variable (price). Ignoring the plus or minus sign, an elasticity greater than 1 is referred to as relatively elastic and an elasticity less than 1 is referred to as relatively inelastic.
Elasticity exactly equal to 1 is known as unit elasticity. Elasticity = (dY/dX) * X/Ywhere X is the independent variable (price, income, etc. ) and Y is the dependent variable (quantity demanded, quantity supplied, etc). Calculating the Percentage Change in Quantity Demanded [700 - 1000] / 1000 = (-300/1000) = -0.3 Calculating the Percentage Change in Price [2.50 –2.20] /2.20 = (0.3/2.20) = 0.1363 Thus elasticity ise = (% Change in Quantity Demanded)/(% Change in Price) e = (-0.3)/(0.1363) = -2.200 For analyzing the price elasticity the negative value is ignored.
The higher the price elasticity, the more sensitive consumers are to price changes. A very high price elasticity suggests that when the price of a good goes up, consumers will buy a great deal less of it and when the price of that good goes down, consumers will buy a great deal more. A very low price elasticity implies just the opposite, that changes in price have little influence on demand. In general, If e > 1 then Demand is Price Elastic (Demand is sensitive to price changes), If e = 1 then Demand is Unit Elastic, If e < 1 then Demand is Price Inelastic (Demand is not sensitive to price changes) Thus, the demand of gasoline is elastic in this case.
This is because, gasoline is easily available at other gas stations and the consumer will buy from the place where it is cheaper. The stations are generally situated at places where demand is high. Since the prices of gasoline rarely goes down, drastically, the areas where demand is high are top priority for gas station owners. At the outskirts or highways, the demand is particularly high The demand for gasoline in US is elastic.
It is very sensitive to price changes. Many people have studied these phenomena in US. One such study ( Molly, n.d. ) examined 101 different studies and found that in the short-run (defined as 1 year or less), the average price-elasticity of demand for gasoline is -0.26. That is, a 10% hike in the price of gasoline lowers quantity demanded by 2.6%. In the long-run (defined as longer than 1 year), the price elasticity of demand is -0.58; a 10% hike in gasoline causes quantity demanded to decline by 5.8% in the long run.
This is probably, because as the price increases, consumers start to look for substitutes to save costs. The use of public transport or pooling of cars etc. are viable options available to people.