What is Price Elasticity?
Price elasticity of demand (PED) measures how responsive quantity demanded is to a change in price. It answers: "If I raise my price by 10%, how much will my sales fall?"
The Formula
PED = % Change in Quantity Demanded / % Change in Price
Example: If price increases 10% and demand falls 20%, PED = -20%/10% = -2.0
Note: PED is typically negative (law of demand), but we often use absolute values for comparison.
Types of Elasticity
| Type | |PED| Value | Meaning | Example |
|---|---|---|---|
| Elastic | > 1 | Demand very responsive to price | Luxury goods, airline tickets |
| Inelastic | < 1 | Demand not very responsive | Gasoline, medicines |
| Unitary | = 1 | % change equal | Rare in practice |
| Perfectly Elastic | ∞ | Any price increase = zero demand | Perfect competition |
| Perfectly Inelastic | 0 | Demand unchanged by price | Life-saving drugs |
What Determines Elasticity?
- Substitutes: More substitutes = more elastic
- Necessity vs. Luxury: Necessities are inelastic
- Budget share: Higher share = more elastic
- Time horizon: More elastic over time
- Brand loyalty: Higher loyalty = less elastic
Business Implications
| If Demand is... | To Increase Revenue... |
|---|---|
| Elastic (|PED| > 1) | Lower prices (volume gain > price loss) |
| Inelastic (|PED| < 1) | Raise prices (price gain > volume loss) |
Conclusion
Key Takeaways
- PED = % change in quantity / % change in price
- Elastic (> 1): Demand responsive; Inelastic (< 1): Not responsive
- Determinants: substitutes, necessity, budget share, time
- Elastic: Lower price to increase revenue
- Inelastic: Raise price to increase revenue