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What is the importance of price elasticity of demand?

A:

Quick Answer

The price elasticity of demand is important because it illustrates the effect that a change in price has on the quantity demanded of a particular good. It may be perfectly elastic, perfectly inelastic or somewhere between the two.

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Full Answer

The price elasticity of demand is determined by dividing the percentage change in the quantity demanded by the percentage change in price. According to Investopedia, when the quotient is zero, price demand is perfectly inelastic. This means that demand does not change when the firm changes the price. In other words, the firm can raise its prices to generate more revenue, without seeing a decrease in sales. A quotient between zero and one means that demand is inelastic, and the percentage change in quantity demanded is less than the percentage change in price. When the quotient is one, price demand is unit elastic, and a change in price yields an equal but inverse change in the quantity demanded. A quotient above one means that demand is perfectly elastic and that a change in price will have a greater effect on the quantity demanded.

Firms whose products have strong brand identity and few substitutes have greater inelasticity; manufacturers of luxury goods are a good example. Firms that sell generic goods with many substitutes have elastic or perfectly elastic demand; commodities such as corn and wheat are perfectly inelastic.

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