If your favorite donut shop were to suddenly increase the price of donuts, would you buy fewer donuts? Your answer is probably yes, but how many fewer donuts would you buy? Price elasticity of demand measures how much consumers adjust the quantity they demand in response to a change in price. In this article, we’ll cover the basics of price elasticity of demand with definitions, formulas, and examples.
What Is Price Elasticity Demand?
In economics, price elasticity of demand measures the degree to which consumers change their quantity demanded in response to a change in price.
If the relative change in quantity demanded is proportionally larger than the change in price, we say the good is elastic—more sensitive to price changes.
If the relative change in quantity demanded is proportionally smaller than the change in price, we say the good is inelastic—less sensitive to price changes.
The analogy of a rubber band can be useful when thinking about elasticity. Just like a stretchy rubber band, the stretchier—i.e., the more elastic—price elasticity is, the larger the adjustment in quantity demanded will be. For goods or services with inelastic—less stretchy—demand, changes in quantity demanded are proportionally smaller.
How To Calculate Price Elasticity Demand?
To calculate price elasticity of demand, all you have to do is take the absolute value of the percentage change in quantity demanded divided by the percentage change in price.
Price Elasticity of Demand(ED)=%Change in Price%Change in Quantity Demanded
As a quick example, say the price of donuts increases by 20%, and in response, you demand 10% fewer donuts. Your price elasticity of demand would be |10%/-20%| or 0.5.
In the elasticity of demand formula, you can calculate percent changes in two ways. The first method is to simply subtract the initial value from the new value and divide the difference by the initial value.
Percentage Change in Quantity=QinitialQnew−Qinitial×100
Percentage Change in Price=PinitialPnew−Pinitial×100
The second method is called the midpoint method. The numerator is the same as in the first method, but in the denominator, you take the average of the new and initial value rather than simply using the initial value. The midpoint method has the advantage of giving you the same elasticity between two price points regardless of whether you are calculating the elasticity for when the price rises or the price declines.
Percentage Change in Quantity=2(Qnew+Qinitial)Qnew−Qinitial×100
Percentage Change in Price=2(Pnew+Pinitial)Pnew−Pinitial×100
Once you’ve calculated price elasticity, you can categorize the elasticity into 1 of 5 zones.
1. Perfectly Inelastic
When the price elasticity of demand is equal to 0, we say the elasticity is perfectly inelastic. This means changes in price have no effect on quantity demanded. Even if the price changes, consumers will not adjust the quantity they demand.
When the price elasticity of demand is less than 1, we say the elasticity is inelastic. This means quantity demanded is relatively insensitive to changes in price. A certain percentage change in price will result in a smaller percentage change in quantity demanded.
3. Unit Elastic or Unitary Elastic
Unit Elastic or Unitary Elastic(ED=1)
When the price elasticity of demand equals 1, we say the elasticity is unit elastic or unitary. This means changes in quantity demanded are proportional to changes in price. A certain percentage change in price will result in the same percentage change in quantity demanded. For example, if the price increases by 10%, quantity demanded falls by 10%.
When the price elasticity of demand is greater than 1, we say the elasticity is elastic. This means quantity demanded is relatively sensitive to changes in price. A certain percentage change in price will result in an even larger percentage change in quantity demanded.
5. Perfectly Elastic
When the price elasticity of demand equals infinity, we say the elasticity is perfectly elastic. This means even a small change in price will reduce the quantity demanded to zero.
Demand Curves and Elasticity
On a demand curve, elasticity can be seen by how steep or flat the demand curve is at a particular point. The steeper the demand curve, the more inelastic demand is, and the flatter the demand curve, the more elastic demand is.
Have a look at the graph below showing two demand curves: D1 and D2
You can see that as the price of the good increases from $10 to $20, quantity demanded changes by a lot more in the flatter, blue demand curve (D1) than it does in the steeper, pink demand curve (D2).
As the price doubles from $10 to $20, quantity demanded decreases by 100-30 or 70 units on the blue curve, while quantity demanded only changes by 5 units on the pink demand curve.
The pink line shows an inelastic demand curve, while the blue line shows an elastic demand curve.
Elasticity Can Change
It’s worth noting that a good or service can fall into many zones of elasticity. In other words, just because a good is inelastic at a certain price point, it does not mean the good or service will be elastic at all other price points.
At a higher price or past a specific point, a good may go from being inelastic to elastic. Similarly, goods can go from being relatively elastic to inelastic over time. This is because consumers have more time to adjust their purchases and look for substitutes.
Examples of Elastic and Inelastic Goods
Take a look at these goods and services based on their estimated price elasticities of demand. These are market-level estimates, but for individual consumers, the elasticities may be different.
Notice that goods without close substitutes, like table salt, are inelastic. Addictive products such as tobacco and alcohol also tend to be inelastic, at least for most of addicted buyers in the market.
Goods and services that have close substitutes tend to be more inelastic. It is easy for consumers to buy less of the good because they can switch to plenty of other products. For example, if restaurant meals become too expensive, you can always eat in. Luxuries such as international travel and fancy cars are also elastic since they are not necessities buyers must buy.
Other Types of Elasticity
Price elasticity of demand is one type of elasticity economists use. Regardless of which type of elasticity you are working with, always remember we use elasticity to measure the responsiveness of one variable to changes in another variable.
Here are some of the other elasticities you’re likely to encounter:
Price Elasticity of Supply
Price elasticity of supply measures the change in quantity supplied relative to changes in price.
Income Elasticity of Demand
Income elasticity of demand measures the change in demand relative to changes in consumer incomes.
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