Elasticity of demand

Question

The elasticity of demand of milk is 0.49. If the price of milk increases 40%, what change in demand would you expect? Be specific about both the direction of the change and how much it changes.

Answer 1

The price elasticity of demand (for a normal good) reflects the Law if Demand, namely that as the price of a good increases, we would expect that Quantity Demanded of a good will decrease (all else being equal). Therefore, if the price of a good increases, we would expect the quantity demanded of that good to decrease.

The magnitude of the change is given by the formula for Price Elasticity if Demand.

Ed = % change in Qd / % change in P

1. Ed = price elasticity of demand = 0.49
2. Qd = quantity demanded of a good
3. P = price of the good

Plugging in our values...

1. Ed = 0.49
2. % change in P = 40% = 0.40

Using a little algebra, we get % change in Quantity Demanded is 0.196 or 19.6%.

The answer is: We expect a 19.6% decrease in Quantity Demanded.

This is consistent with the degree of elasticity.

Ed > 1 : Elastic Demand

Ed = 1 : Unit Price Elasticity

Ed < 1 : Inelastic Demand

Inelastic goods are “necessities”, like milk or gas, and aren’t as responsive to price changes. People would still purchase the product in the face of price increases because they consider it a necessity.

Note: Price Elasticity of Demand compares the relative changes in Price and Quantity Demanded. Even if the relationship is negatively correlated, the sign of Ed is positive.