What Is Price Elasticity of Demand?
Price elasticity of demand is a measurement of the change in the consumption of a product in relation to a change in its price. Expressed mathematically, it is:
Price Elasticity of Demand = Percentage Change in Quantity Demanded / Percentage Change in Price
Economists use price elasticity to understand how supply and demand for a product change when its price changes.
- Price elasticity of demand is a measurement of the change in consumption of a product in relation to a change in its price.
- A good is elastic if a price change causes a substantial change in demand or supply.
- A good is inelastic if a price change does not cause demand or supply to change very much.
- The availability of a substitute for a product affects its elasticity. If there are no good substitutes and the product is necessary, demand won’t change when the price goes up, making it inelastic.
What Is Elasticity?
Understanding Price Elasticity of Demand
Economists have found that the prices of some goods are very inelastic. That is, a reduction in price does not increase demand much, and an increase in price does not hurt demand either. For example, gasoline has little price elasticity of demand. Drivers will continue to buy as much as they have to, as will airlines, the trucking industry, and nearly every other buyer.
Other goods are much more elastic, so price changes for these goods cause substantial changes in their demand or their supply.
Not surprisingly, this concept is of great interest to marketing professionals. It could even be said that their purpose is to create inelastic demand for the products they market. They achieve that by identifying a meaningful difference in their products from any others that are available.
If the quantity demanded of a product changes greatly in response to changes in its price, it is elastic. That is, the demand point for the product is stretched far from its prior point. If the quantity purchased shows a small change after a change in its price, it is inelastic. The quantity didn’t stretch much from its prior point.
Availability of substitutes is a factor
The more easily a shopper can substitute one product for another, the more the price will fall. For example, in a world in which people like coffee and tea equally, if the price of coffee goes up, people will have no problem switching to tea, and the demand for coffee will fall. This is because coffee and tea are considered good substitutes for each other.
Urgency is a factor
The more discretionary a purchase is, the more its quantity of demand will fall in response to price increases. That is, the product demand has greater elasticity.
Say you are considering buying a new washing machine, but the current one still works; it's just old and outdated. If the price of a new washing machine goes up, you’re likely to forgo that immediate purchase and wait until prices go down or the current machine breaks down.
The less discretionary a product is, the less its quantity demanded will fall. Inelastic examples include luxury items that people buy for their brand names. Addictive products are quite inelastic, as are required add-on products, such as ink-jet printer cartridges.
One thing all of these products have in common is that they lack good substitutes. If you really want an Apple iPad, a Kindle Fire won’t do. Addicts are not dissuaded by higher prices, and only HP ink will work in HP printers (unless you disable HP cartridge protection).
Sales skew the numbers
The length of time that the price change lasts also matters. Demand response to price fluctuations is different for a one-day sale than for a price change that lasts for a season or a year.
Clarity of time sensitivity is vital to understanding the price elasticity of demand and for comparing it with different products. Consumers may accept a seasonal price fluctuation rather than change their habits.
Example of Price Elasticity of Demand
As a rule of thumb, if the quantity of a product demanded or purchased changes more than the price changes, the product is considered to be elastic. (For example, the price goes up by 5%, but the demand falls by 10%.)
If the change in quantity purchased is the same as the price change (say, 10%/10% = 1), the product is said to have unit (or unitary) price elasticity.
Finally, if the quantity purchased changes less than the price (say, -5% demanded for a +10% change in price), then the product is deemed inelastic.
To calculate the elasticity of demand, consider this example: Suppose that the price of apples falls by 6% from $1.99 a bushel to $1.87 a bushel. In response, grocery shoppers increase their apple purchases by 20%. The elasticity of apples is thus: 0.20/0.06 = 3.33. The demand for apples is quite elastic.
What Is Price Elasticity of Demand?
Price elasticity of demand is the ratio of the percentage change in quantity demanded of a product to the percentage change in price. Economists employ it to understand how supply and demand change when a product’s price changes.
What Makes a Product Elastic?
If a price change for a product causes a substantial change in either its supply or demand, it is considered elastic. Generally, it means that there are acceptable substitutes for the product. Examples would be cookies, luxury automobiles, and coffee.
What Makes a Product Inelastic?
If a price change for a product doesn’t lead to much if any change in its supply or demand, it is considered inelastic. Generally, it means that the product is considered to be a necessity or a luxury item with addictive constituents. Examples would be gasoline, milk, and iPhones.