Price Elasticity of Demand

Price elasticity of demand measures how sensitive the quantity demanded of a good or service is to a change in its price. It expresses the percentage change in quantity demanded resulting from a one-percent change in price.

Formula and interpretation

Price elasticity of demand (PED) = (% change in quantity demanded) ÷ (% change in price)

Interpretation:
* PED > 1: elastic — quantity demanded changes proportionally more than price.
* PED = 1: unitary elasticity — quantity and price change by the same percentage.
* 0 < PED < 1: inelastic — quantity demanded changes proportionally less than price.
* PED = 0: perfectly inelastic — quantity demanded does not change with price.
* PED → ∞: perfectly elastic — any tiny price change causes demand to drop to zero.

Example: If price falls 6% and quantity demanded rises 20%, PED = 20% ÷ 6% = 3.33 (elastic).

How it works

Think of elasticity like a rubber band: elastic demand stretches a lot with price changes; inelastic demand barely stretches. Elasticity depends on consumer willingness and ability to substitute or postpone purchases when price changes.

Key factors that affect elasticity

• Availability of substitutes — more substitutes → more elastic demand (e.g., many coffee brands).
• Necessity vs. luxury — necessities tend to be inelastic; luxuries more elastic.
• Share of budget — items that consume a larger share of income tend to be more elastic.
• Time horizon — demand usually becomes more elastic over time as consumers find substitutes or adjust habits.
• Market definition — narrowly defined goods (a specific brand) are more elastic than broadly defined categories (food).
• Habit, addiction, or brand loyalty — these make demand more inelastic.
• Duration and frequency of price change — temporary sales often generate different responses than permanent price changes.

Types and examples

• Perfectly elastic (PED → ∞): identical products in perfectly competitive markets (theoretical).
• Elastic (PED > 1): many consumer goods—cookies, nonessential electronics.
• Unitary (PED = 1): proportionate response—some aggregate demand cases.
• Inelastic (0 < PED < 1): necessities—gasoline (short run), milk, basic medicines.
• Perfectly inelastic (PED = 0): life-saving drugs with fixed required doses (theoretical ideal).

Why it matters

• Pricing strategy — knowing PED helps businesses decide whether to raise or lower prices to maximize revenue. If demand is elastic, lowering price can increase total revenue; if inelastic, raising price can increase revenue.
• Tax policy and incidence — governments use PED to predict how taxes affect consumption and who bears the tax burden.
• Production and inventory planning — manufacturers use elasticity estimates to forecast demand changes from price moves or promotions.
• Marketing — firms attempt to make demand more inelastic by differentiating products and fostering brand loyalty.

Bottom line

Price elasticity of demand quantifies consumer responsiveness to price changes. Products with many substitutes and discretionary purchases tend to be elastic; necessities and unique or addictive goods tend to be inelastic. Understanding PED helps businesses and policymakers make informed pricing, production, and tax decisions.