What is Price Elasticity of Demand?

Jeremy Cook, Ellie Funke
  • Author
    Jeremy Cook

    Jeremy taught elementary school for 18 years in in the United States and in Switzerland. He has a Masters in Education from Rollins College in Winter Park, Florida. He's taught grades 2, 3, 4, 5 and 8. His strength is in educational content writing and technology in the classroom

  • Instructor
    Ellie Funke

    Ellie has a Masters in Health Administration and a Masters in Business Administration.

Learn what price elasticity is. Discover how to find price elasticity of demand, study examples of price elasticity, and examine a price elasticity graph. Updated: 02/01/2022

What Is Price Elasticity?

People who have worked out with resistance bands know there are different types of bands that provide different levels of resistance. The bands look the same, but when force is applied to them, they react in different ways. Some bands are easier to stretch than others. The different bands have different elasticities, with the heavier bands being more inelastic and the lighter bands being more elastic. But what do workout bands have to do with economics, and what is price elasticity of demand and the price elasticity meaning?

The price elasticity of demand definition in economics is the relationship between the change in quantity demanded of a good or service and the change in price. There are other measures of elasticity as well. There is income elasticity, which measures the relationship between consumer incomes and demand for products. There is also the price elasticity of supply, which measures the relationship between price changes and the supply available of the goods or services.

There are two basic terms associated with elasticity. Inelastic is the term for a good that does not see a dramatic change in demand with a change in price. Gas is a good example of an inelastic good. People need a certain amount of gas to commute and run errands. If the price rises, they still need the same amount of gas. If the price lowers, it is not a product that people can stock up on very easily.

Elastic is the term used for goods that see a much more dramatic change in demand compared to the price. Goods that are not necessary to daily life tend to be more elastic. If the cost of an espresso machine doubled, the demand would plummet because people do not need one, so they will not purchase them if the price increases too much.

Why is price elasticity important to economics? Understanding the relationship between price and demand is a key component to successful business and marketing strategy. If a company can raise prices without having demand drop, it might make sense to increase prices. But if a small price increase will result in a dramatic drop in demand, they may want to reconsider a price increase.

Factors of Elasticity

There are several factors that can affect the elasticity of a product. Products that consumers buy fall into two general categories; necessary goods and luxury goods. In the consumer world, people think of luxury as very expensive products, but in economics, luxury goods are goods that are not required for basic life or survival. Food, clothing, and housing are considered necessary goods while televisions, cars, and jewelry are considered luxury goods. So what are some factors of elasticity?

  • Type of Good - The more a good or service is necessary, the more inelastic it becomes. Food and clothing are examples of goods that are more inelastic because they are a necessary good. While the brands or types of food and clothing might change, people will need food staples like butter, flour, rice, and milk. They will also need clothing like socks, underwear, pants, shirts, and jackets. The more a good moves into the luxury category, the more elastic the price is. High-end electronics are highly elastic. Demand tends to soar during huge sale events like Black Friday, and will drop significantly when prices rise. They will also see dramatic drops in demand if overall incomes drop.
  • Substitutes - Substitute goods are when one product that a consumer buys can be easily substituted for another. If a particular brand of shoes significantly raises their prices, consumers have a myriad of other shoe brands to substitute. The more substitute options a consumer has, the more elastic a good is. Conversely, when there are few or no substitutes, the price tends to be inelastic because there are no other options. School-required textbooks that cannot be substituted, a person's prescribed medicine, or the use of the only taxi service in the area are examples of inelastic goods and services due to lack of substitutes.


Most school textbooks do not have any substitutes, so the demand is inelastic.

An image of a textbook, which is an inelastic good


  • Time - The period of time that a good or service sees an increase or decrease in price can change the elasticity of a good. Assume the price of pickup trucks dramatically increases to the point that makes it hard for some buyers to purchase. If the time period that the price increase remains in place is short, the demand might stay more steady. If the increase lasts too long, truck buyers might be forced to purchase another type of vehicle that they end up liking better. This would make the price of trucks more elastic as buyers are forced to switch to different products.

Price Elasticity of Demand Defined

Price elasticity of demand is the relationship of consumer response to change in price of a product or service. The degree of change along the demand curve relative to the degree of change in price will more clearly show the effect of a price change. The formula:

Price Elasticity of Demand = % of change in Quantity Demanded / % of change in Price

provides the change for unit demand for each unit change in price.

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How to Find Price Elasticity of Demand

While it might seem complex to determine how elastic a good is based on price and demand, the formula is actually quite simple.

Price Elasticity of Demand = % of change in quantity demanded / % of change in price

The two main groups of elasticity are based on the results of the calculation of the elasticity of demand. The resulting number is called the elasticity value. In most cases the numbers stat between -5 and 5.

  1. Relatively Inelastic - When the elasticity value is between 0 and 1. These are good are considered necessary goods and include staples like flour, rice, gas, and oil.
  2. Relatively Elastic - Goods with an elasticity value greater than 1 are considered elastic. The percentage change in price will be less than the change in demand. If a product's price increases by 10%, the demand decreases by 15%.

There are two other ways to view and calculate price elasticity.

  • Point Elasticity - This calculation takes the main formula one step further. Instead of looking at the entire graph of the change in price versus the change in demand, it focuses on a specific point on the graph. If the price of a good slowly rose to $60, the point elasticity could tell what the demand was when the good was priced at $50.
  • Midpoint Method - The midpoint method takes the average percent change in price and the average change in demand and then calculates the elasticity. The midpoint can help to even out any spikes in price or demand that might throw off the total chart. It is similar to using the median in a data sent instead of the mean.

Price Elasticity Meanings

Depending on value of the elasticity of a good, economists will place the good in one of the following categories.

Inelastic and Elastic

Some products are more sensitive to increases, like bread or sorbet that may be easily substituted. Other products that are relatively inelastic include products that exist in a market without competition, like utilities, or necessities, like healthcare and some prescriptions.

When a product is inelastic, there will be less variation in demand relative to a variation in price. If the coefficient is < 1, then it's considered inelastic. This means the buyer isn't as sensitive to a price change.

Unit elasticity occurs when the same percentage is found for the change in price as for the change in demand. Whether it's a decrease in demand or an increase in demand, we can say that a proportionally equivalent change is considered unit elasticity. This means that for every unit percent of change in price, the buyer responds to an equivalent unit of change in quantity demanded.

Elastic demand curve

When a product or service is elastic, the coefficient is > 1. The graph shows what the demand curve looks like when it is elastic. When the price of the product goes down 33%, consumers respond by increasing quantity demanded by 110%. Since 1.10 / .33 is greater than 1, it is considered elastic.

Formula

To figure out price elasticity, we look at the formula where E(sub)d is price elasticity of demand and see it is found in the percent of change in quantity demanded divided by the percent of change in price.

E(sub)d = ((Qd2 -Qd1 ) / Qd1) / ((P2 - P1) / P1)

E(sub)d = Price elasticity of demand

Qd1 = Original quantity demanded

Qd2 = Quantity demanded after the change in price

P1 = Original price

P2 = Price after change

Comparing the percentages of change for each variable, Qd and P, tells us more about the relativity than if we compared just the value of the change.

Here is an example of how to figure the price elasticity of demand:

Your sole source power company has increased your unit cost of electricity 25%. You may start turning off lights, stop blow-drying your hair, and turn down the thermostat. With your new bill, we calculate the price elasticity of electricity.

We have the percentage change in price for a kWh. Now we need to find the percentage change in quantity demanded.

Last month kWh used = 1,500

This month kWh used = 1,200

Delta of Q = 1,500 - 1,200 = 300; 300 / 1,500 = 20%.

Delta of P = 25%

Now that we have the first two parts of the formula, we can easily calculate the last part.

E(sub)d = .20 / .25 = .80

The price elasticity of the demand for electricity is .80. Since that is less than one, we can determine that it is inelastic.

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Video Transcript

Price Elasticity of Demand Defined

Price elasticity of demand is the relationship of consumer response to change in price of a product or service. The degree of change along the demand curve relative to the degree of change in price will more clearly show the effect of a price change. The formula:

Price Elasticity of Demand = % of change in Quantity Demanded / % of change in Price

provides the change for unit demand for each unit change in price.

Inelastic and Elastic

Some products are more sensitive to increases, like bread or sorbet that may be easily substituted. Other products that are relatively inelastic include products that exist in a market without competition, like utilities, or necessities, like healthcare and some prescriptions.

When a product is inelastic, there will be less variation in demand relative to a variation in price. If the coefficient is < 1, then it's considered inelastic. This means the buyer isn't as sensitive to a price change.

Unit elasticity occurs when the same percentage is found for the change in price as for the change in demand. Whether it's a decrease in demand or an increase in demand, we can say that a proportionally equivalent change is considered unit elasticity. This means that for every unit percent of change in price, the buyer responds to an equivalent unit of change in quantity demanded.

Elastic demand curve

When a product or service is elastic, the coefficient is > 1. The graph shows what the demand curve looks like when it is elastic. When the price of the product goes down 33%, consumers respond by increasing quantity demanded by 110%. Since 1.10 / .33 is greater than 1, it is considered elastic.

Formula

To figure out price elasticity, we look at the formula where E(sub)d is price elasticity of demand and see it is found in the percent of change in quantity demanded divided by the percent of change in price.

E(sub)d = ((Qd2 -Qd1 ) / Qd1) / ((P2 - P1) / P1)

E(sub)d = Price elasticity of demand

Qd1 = Original quantity demanded

Qd2 = Quantity demanded after the change in price

P1 = Original price

P2 = Price after change

Comparing the percentages of change for each variable, Qd and P, tells us more about the relativity than if we compared just the value of the change.

Here is an example of how to figure the price elasticity of demand:

Your sole source power company has increased your unit cost of electricity 25%. You may start turning off lights, stop blow-drying your hair, and turn down the thermostat. With your new bill, we calculate the price elasticity of electricity.

We have the percentage change in price for a kWh. Now we need to find the percentage change in quantity demanded.

Last month kWh used = 1,500

This month kWh used = 1,200

Delta of Q = 1,500 - 1,200 = 300; 300 / 1,500 = 20%.

Delta of P = 25%

Now that we have the first two parts of the formula, we can easily calculate the last part.

E(sub)d = .20 / .25 = .80

The price elasticity of the demand for electricity is .80. Since that is less than one, we can determine that it is inelastic.

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Frequently Asked Questions

How do you calculate the price elasticity of demand?

There are three main steps to finding the value of the price elasticity of demand. The first step is to determine the percentage change in quantity by dividing the change in quantity demanded by the new quantity demanded. The second step is to find the change in price by dividing the change in price by the original price. The third step is to dived the change in quantity demanded by the change in price to get the elasticity.

What does price elasticity mean?

Price elasticity is the relationship between the price of a good and the quantity demanded at the given price level. If the demand drops to a greater degree than the price rises, the good is elastic and if the change in demand is less than the change in price, the good is more inelastic.

What is an example of price elasticity?

Price elasticity is the relationship between price changes and demand changes. If the price of a coffee maker rises by 10% and the demand drops by 15%, the coffee machine is considered elastic. If the price of a gallon of milk rises 20% but the demand stays the same, the milk is considered inelastic.

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