Economics

# Price Elasticity of Demand

The price elasticity of demand is the ratio of the percentage change in quantity demanded to the percentage change in price for a product. Economists use it to understand how supply and demand change when the price of a product changes. If the demand for a product changes significantly in response to a price change, it is said to be elastic. Soft drinks, clothing, luxury items, automobiles, and other items with elastic demand are examples.

The price elasticity of demand measures the change in consumption of a product in response to a change in its price. It is expressed mathematically as follows:

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.

Supply, like demand, has an elasticity known as price elasticity of supply. The relationship between change in supply and change in price is referred to as price elasticity of supply. It is calculated by dividing the percentage change in quantity supplied by the price change. The two elasticities work together to determine what goods are produced at what prices.

The price elasticity of demand measures the change in consumption of a product in response to a price change. If the price elasticity of a good is infinite, it is perfectly elastic (if demand changes substantially even with minimal price change). If the price elasticity is greater than one, the good is elastic; if it is less than one, the good is inelastic.

If a good’s price elasticity is 0 (no amount of price change produces a change in demand), it is perfectly inelastic. If price elasticity is exactly 1 (price change leads to an equal percentage change in demand), it is known as unitary elasticity. 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.

Example

It is considered elastic if a price change for a product causes a significant change in either its supply or demand. In general, it indicates that the product has acceptable substitutes. Cookies, high-end automobiles, and coffee are a few examples.

A product is considered inelastic if a price change has little, if any, effect on its supply or demand. In general, it means that the product’s addictive constituents are regarded as a necessity or a luxury item. Gasoline, milk, and iPhones are some examples.

Application

Knowing the price elasticity of demand for a good allows someone selling that good to make informed pricing decisions. This metric informs sellers about the pricing sensitivity of their customers. It is also critical for manufacturers to determine manufacturing plans, as well as for governments to determine how to tax goods.