Price Elasticity of Demand

Price elasticity of demand (PED) measures how responsive the quantity demanded of a good is to a change in its price. It is expressed as the percentage change in quantity demanded divided by the percentage change in price.

Formula:
Price Elasticity of Demand = % change in quantity demanded ÷ % change in price
Because demand usually falls when price rises, PED is typically negative; analysts often report its absolute value (magnitude) for interpretation.

How to interpret PED

• |PED| > 1 — Elastic: quantity demanded changes more than price (sensitive to price).
• |PED| = 1 — Unitary elasticity: quantity demanded changes by the same percentage as price.
• |PED| < 1 — Inelastic: quantity demanded changes less than price (insensitive to price).
• |PED| = 0 — Perfectly inelastic: quantity demanded does not change with price.
• |PED| = ∞ — Perfectly elastic: any price change causes demand to drop to zero (idealized case).

Example

If price falls by 6% and quantity demanded rises by 20%:
PED = 20% ÷ 6% = 3.33 → demand is elastic.

Common types and examples

• Elastic goods: many close substitutes or nonessential items (e.g., cookies, some consumer electronics, generic brands).
• Inelastic goods: necessities or goods with few substitutes (e.g., gasoline, certain medicines, basic utilities).
• Luxury vs necessity: luxuries tend to have higher elasticity; necessities lower.
• Addictive or required complementary goods (e.g., cigarettes, proprietary ink cartridges) often show inelastic demand.

Factors that affect price elasticity

• Availability of substitutes: More substitutes → higher elasticity.
• Necessity versus luxury: Necessities → lower elasticity; luxuries → higher.
• Proportion of income: Higher-cost items that take a larger budget share tend to be more elastic.
• Time horizon: Demand is usually more elastic in the long run as consumers find alternatives or adjust behavior.
• Brand loyalty and product differentiation: Strong brand loyalty or perceived uniqueness makes demand more inelastic.
• Urgency and durability: Urgent needs and durable goods can alter short-term responsiveness.

Why PED matters

• Pricing strategy: If demand is elastic, lowering price can increase total revenue; if inelastic, raising price may increase revenue.
• Tax policy: Taxing inelastic goods raises government revenue with smaller reductions in quantity demanded.
• Production and inventory planning: Understanding responsiveness guides supply decisions and capacity planning.
• Marketing: Firms try to reduce elasticity by differentiating products, building loyalty, or creating perceived necessity.

Key takeaways

• PED quantifies consumer sensitivity to price changes; use the magnitude to classify elasticity.
• Substitutes, necessity, income share, time, and brand strength are major determinants.
• Firms and governments use PED to inform pricing, taxation, and production decisions.