Price elasticity of demand

How useful is knowledge of price elasticity for a business?

What is elasticity?
Price Elasticity of Demand(PED) is something used in microeconomics to see how much a change in price affects the demand.

The formula for PED = %change Demand/ %change price
Since changes in price and demand nearly always move in opposite direction economists mostly don't bother to put in the '-' sign.

There can be 4 outcomes of this formula.

1) PED= 0, the demand is perfectly elastic. The graph will show a vertical line.

2) PED is between 0 and 1,inelastic. The graph will show a steep line.

3) PED=1, demand is unit elastic, 15% increase in price will make demand fall for 15%.

4) PED is greater than 1, demand is elastic. The graph will show a (nearly) flat line.

Now we know this, how do producers apply this?

In case of outcome 2 and 4 producers will be able to raise the total revenues by using the PED. (see graphs below)


Source: www.tutor2u.net/economics/revision-notes/as-markets-price-elasticity-of-demand.html

The situation shown on the left shows a relatively inelastic demand. In the picture it shows that a move from P1 to P2 caused the move from Q1 to Q2. However, due to the inelasticity of this good the move from P1 to P2 is way bigger than the move from Q1 to Q2. That's why the total revenues are increased going from situation 1 to situation 2.( Dark area shows total revenues in situation 1, light area shows total revenues in situation 2)
So for an inelastic environment producers should incease prices to make total revenues increase.

The situation shown on the right shows a relatively elastic demand. In the picture it shows that a move from P1 to P2 caused the move from Q1 to Q2. However, due to the elasticity of this good the move from P1 to P2 is way smaller than the move from Q1 to Q2. That's why the total revenues increase going from situation 1 to situation 2.( Dark area shows total revenues in situation 1, light area shows total revenues in situation 2)
So for an elastic environment producers should decrease prices to make total revenues increase.


In the end I think elasticity is something that's very important for producers to know aout and it's a very valuable tool for increasing total revenues.