Demand Elasticity

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DEFINITION of 'Demand Elasticity'

In economics, the demand elasticity refers to how sensitive the demand for a good is to changes in other economic variables. Demand elasticity is important because it helps firms model the potential change in demand due to changes in price of the good, the effect of changes in prices of other goods and many other important market factors. A firm grasp of demand elasticity helps to guide firms toward more optimal competitive behavior. Elasticities greater than one are called "elastic," elasticities less than one are "inelastic," and elasticities equal to one are "unit elastic."

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BREAKING DOWN 'Demand Elasticity'

Demand elasticity is a measure of how much the quantity demanded will change if another factor changes. One example is the price elasticity of demand; this measures how the quantity demanded changes with price. This is important for setting prices so as to maximize profit.

When price elasticity of demand is elastic, the firm should lower prices, since it will result in a big uptick in demand, increasing your total revenue. When price elasticity of demand is inelastic, you should increase prices because there will be only a small decrease in demand, and again, total revenue will increase. When price elasticity of demand is unit elastic, changing the price will not change total revenue, since price and quantity will generally change in lock step with each other.

 

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RELATED FAQS
  1. What are some examples of demand elasticity other than price elasticity of demand?

    Demand elasticity is an economic measure of the sensitivity of demand relative to a change in another variable. The quantity ... Read Full Answer >>
  2. Which factors are more important in determining the demand elasticity of a good or ...

    Demand elasticity measures how sensitive the quantity demanded of a good or service is to changes in other variables. Many ... Read Full Answer >>
  3. What factors influence a change in demand elasticity?

    Demand elasticity is the sensitivity of the demand for a good or service due to a change in another factor. There are many ... Read Full Answer >>
  4. What is the effect of price inelasticity on demand?

    Price inelasticity is very beneficial for businesses. It offers firms greater flexibility with prices while the percentage ... Read Full Answer >>
  5. What is the difference between inelasticity and elasticity of demand?

    Inelasticity and elasticity of demand are the respective end ranges for the formulaic comparison of price and demand for ... Read Full Answer >>
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    The Federal Reserve can increase aggregate demand in indirect ways by lowering interest rates. Aggregate demand is a measure ... Read Full Answer >>

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