Simple - enter the following items:
And hit the calculate button. The tool will calculate the price elasticity of demand and change in aggregate revenue.
The most commonly accepted formula for calculating price elasticity of demand is the midpoint formula.
In conventional economics, demand for a product is traditionally modeled as a convex curve; the change in demand for the product
shifts as you move to the left or the right of the curve. The mid-point formula attempts to the address. Since we have both the
old and the new price-demand points, we infer the curve passed through the mid-point of the two. We compare the aggregate change
in price with the price and quantity sold at the midpoint to get the average rate of change. This is generally expressed as:
Midpoint Price Elasticity Formula: ((Q1 - Q0) / (P1 - P0)) * ((P1+P0)/2)/(Q1+Q0)/2))
Because demand for a product generally increases as the price is lowered and declines as the price increases. The change in price affects the likelihood of consumers using substitute products or taking steps to reduce their aggregate demand. The degree to which this occurs gives us valuable information about the nature of the consumer demand. We can interpret the price elasticity of demand value into several buckets:
An interesting edge case where demand for the product increases as the average price increases. They are rare and there's some debate if they actually exist (evidence points in this direction). The textbook example is an inferior good for which there are few viable substitutes. If we imagine a poor consumer on a limited budget, they have a choice between two types of food with which to feed their family: a staple (cheap basic food) and a treat (meat or premium food). Since getting a full pantry is the goal, they will buy enough of the staple to ensure a full pantry and top off their purchases with some of the "treat". In this simple example, raising the price of the staple will actually increase demand for the staple. There is no viable substitute for the staple with a lower cost - and the consumer is compelled to fill out their pantry before buying the treat. Thus higher prices for the staple consume a greater share of the consumer's budget, leaving less money for the treat. They will buy more of the staple and less of the premium goods due to a limited budget. This effect would quickly collapse if a lower priced substitute existed.
Veblen Goods are another edge case where demand increases as the average price rises. Unlike Giffen Goods, these are generally high quality products with a premium brand and consumer demand as a status symbol. The higher price confers greater snob appeal. If the price is increased, it actually increaes the value of consuming the product as a social signal, since it is now further out of reach of the average consumer. Similarly, if the price is reduced the influx of lower status consumers will chase out the elite customer base. Think expensive wine, designer clothing, products sold in fancy boutiques and via personalized consultation.
If the price elasticity is greater than one, that means that the price for the product is elastic. This means you will see significant incremental demand in response to a price decrease, resulting in an increase in aggregate dollar sales of the product (total revenue). If the price elasticity of a product is less than one, we say the product is inelastic. Price decreases will result in decrease in aggregate revenue.