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1. Responsiveness of demand to changes in price

According to the law of demand, when the price of a good rises, the quantity demanded will fall. But in most cases we want to know how much the quantity demanded will fall. In other words, we will want to know how responsive demand is to a rise in price.
Take the case of two products: oil and tangerines. In the case of oil, a rise in price is likely to result in a slight fall in the quantity demanded. If people want to continue driving, they have to pay the higher prices for fuel. Some may turn to using public transportation, and some people may try to use the car less often, but for most people, a rise in the price of petrol and diesel will make little difference to how much they use their cars.
In the case of tangerines, however, a rise in price may lead to substantial fall in the quantity demanded. The reason is that there are alternative fruits that people can buy: oranges, apples, or bananas.
The responsiveness of demand to a change in price is called the price elasticity of demand. If we know the price elasticity of demand for a product, we can predict the effect on price and quantity of a shift in the supply curve for that product.
Measuring the price elasticity of demand: We need to compare the size of the change in quantity demanded with the size of the change in price in percentage. This gives us the following formula for the price elasticity of demand (Pε_d):
Pε_d = %∆Q_d / %∆P
where ε (a Greek letter ‘epsilon’) is the symbol we use for elasticity, and ∆ (a capital Greek letter ‘delta’) is the symbol we use for ‘a change in’, Q is quantity, and P is price.
For example, if a 40 per cent rise in the price of oil caused the quantity demanded to fall by 10 per cent, the price elasticity of oil would be:
– 10% / 40% = – 0.25
On the other hand, if a 5 per cent fall in the price of tangerines caused a 15 per cent rise in the quantity demanded, the price elasticity of demand for tangerines would be: 15% / – 5% = – 3
The figures (–0.25 and –3) show that tangerines have a more elastic demand than oil. The sign is negative, because price and quantity change in opposite directions. Thus when calculating price elasticity of demand, we either divide a negative change by a positive figure, or positive figure by a negative.
The value (greater or less than 1): if we focus on the number and ignore the sign, we can know whether demand is elastic or inelastic.

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