Calculator
Definition – What is price elasticity of demand?
Price elasticity of demand (PED) measures how much the quantity demanded of a good or service changes in response to a change in its price. It helps businesses understand how sensitive consumers are to price fluctuations.
- If PED > 1, demand is elastic, meaning consumers are very responsive to price changes, and a small price increase could lead to a large change in demand.
- If PED < 1, demand is inelastic, meaning consumers are less responsive to price changes, and price shifts have little effect on quantity demanded.
- If PED = 1, demand is unit elastic, meaning a price change leads to a proportional change in quantity demanded.
Elasticity helps businesses set pricing strategies. For example, if demand is inelastic, firms may raise prices without a large drop in sales, but with elastic demand, price increases might significantly lower sales.
Formula – How to calculate price elasticity of demand
Price Elasticity of Demand = (% Change in Demand) ÷ (% Change in Price)
Where:
- % Change in Quantity Demanded is the percentage change in the number of units consumers buy. % Change in Demand = (Demand (end) – Demand (start)) ÷ Demand (start)
- % Change in Price is the percentage change in the price of the good. % Change in Price = (Price (end) – Price (start)) ÷ Price (start)
Example
Suppose the price of a product increases by 10%, and as a result, the quantity demanded falls by 20%. The price elasticity of demand is:
PED = −20% ÷ 10% = −2
This indicates that the demand for the product is elastic, as a small price increase leads to a significant decrease in quantity demanded.
What is Price Elasticity of Demand Used For?
Price elasticity of demand helps businesses make pricing decisions and forecast revenue changes. By understanding whether demand is elastic or inelastic, companies can adjust prices strategically. For example, if demand is elastic, a price increase could lead to a large drop in sales, reducing total revenue. However, if demand is inelastic, the firm could raise prices without a significant decrease in sales, potentially increasing revenue.
Governments also use PED to predict how changes in taxation or regulation might impact consumption of goods, such as fuel or cigarettes.
Price Elasticity of Demand vs. Cross-Price Elasticity of Demand
Cross Price Elasticity of Demand (XED) Calculator & FormulaWhile price elasticity of demand measures how the demand for a good changes due to its own price changes, cross-price elasticity of demand (XED) examines how the quantity demanded of one good changes when the price of another related good changes. Cross-price elasticity helps identify whether goods are substitutes or complements, whereas PED focuses solely on how consumers respond to changes in a single product’s price.
Price Elasticity of Demand vs. Income Elasticity of Demand
Price elasticity of demand focuses on how sensitive the quantity demanded is to price changes. In contrast, income elasticity of demand (YED) measures how the quantity demanded changes in response to changes in consumers’ income. YED helps determine whether a good is a normal good (demand increases as income rises) or an inferior good (demand decreases as income rises).
Sources and more resources
- Wikipedia contributors. (2024e, August 17). Price elasticity of demand. Wikipedia. https://en.wikipedia.org/wiki/Price_elasticity_of_demand
- Khan Academy. (n.d.-h). https://www.khanacademy.org/economics-finance-domain/microeconomics/elasticity-tutorial/price-elasticity-tutorial/v/price-elasticity-of-demand
- Kacapyr, E., & Redelsheimer, J., & Musgrave, F. Barron’s AP Microeconomics / Macroeconomics (6th ed.). (2018). United States of America: Barron’s. ISBN: 978-1-4380-1065-6. Page 65.
- Pindyck, R., & Rubinfeld, D., Microeconomics (8th ed.), (2013). United States of America: Pearson. ISBN 13: 978-0-13-285712-3. Page 33.
- Nicholson, W., & Snyder, C. Microeconomic Theory – Basic Principles and Extensions (10th ed.). (2008). United States of America: Thomas South-Western. ISBN 13: 978-0-324-42162-0. Page 26.
- Greenlaw, S., & Shapiro, D., Principles of Microeconomics 2e. (2018). Houston: Rice University OpenStax. ISBN 13: 978-1-947172-35-7. Page 107.