Price Elasticity of Demand: Meaning, Types, and Factors That Impact It

What Is Price Elasticity of Demand?

Price elasticity of demand is a measurement of the change in the demand for a product as a result of a change in its price. If a price change creates a large change in demand, that is known as elastic demand. If a price change creates a small change in demand, that is an inelastic demand.

Understanding Price Elasticity of Demand

Economists have found that the prices of some goods are very inelastic. That is, a reduction in price does not increase demand much, and an increase in price does not hurt demand, either. This usually happens when there is no good substitute for a product, so consumers must continue purchasing it even if the price changes.

Gasoline, for example, has little price elasticity of demand. Drivers will continue to buy as much as they have to, as will industries such as airlines and trucking

Other goods are much more elastic, so price changes for these goods cause substantial changes in their demand or their supply.

If the quantity demanded of a product changes greatly in response to changes in its price, it is elastic. That is, the demand point for the product is stretched far from its prior point. If the quantity purchased shows a small change after a change in its price, it is inelastic. The quantity didn’t stretch much from its prior point. 

Price elasticity of demand can be expressed mathematically as:

Price Elasticity of Demand = Percentage Change in Quantity Demanded ÷ Percentage Change in Price

Factors That Affect Price Elasticity of Demand

How elastic a product is depends on a variety of factors that can change over time. Some of these factors are within a business's control. Others are a matter of market conditions.

Availability of Substitutes

The more easily a shopper can substitute one product for another, the more elastic demand for those products will be. For example, if shoppers like coffee and tea equally, they will be happy to switch to tea if the price of coffee goes up. When this happens, the demand for coffee will fall. This is because coffee and tea are considered good substitutes for each other.

Urgency

The more discretionary a purchase is, the more its quantity of demand will fall in response to price increases. That is, the product demand has greater elasticity.

Say you are considering buying a new washing machine, but the current one still works; it’s just old and outdated. If the price of a new washing machine goes up, you’re likely to forgo that immediate purchase and wait until prices go down or the current machine breaks down.

The less discretionary a product is, the less its quantity demanded will fall in response to price changes. Inelastic examples include:

• Luxury items, especially those bought specifically because of their brand names
• Addictive products, such as cigarettes
• Required add-on products, such as the correct ink for printers
  

One thing all these products have in common is that they lack good substitutes. If you really want an Apple iPad, then a Kindle Fire won’t do, even if the price of the iPad goes up. Addicts are not dissuaded by higher prices, and only one kind of ink cartridge will work in your printer.

Duration of Price Change

The length of time that the price change lasts also matters. Demand response to price fluctuations is different for a one-day sale than for a price change that lasts for a season or a year.

Clarity of time sensitivity is vital to understanding the price elasticity of demand and for comparing it with different products. Consumers may accept a seasonal price fluctuation rather than change their habits. For example, it will cost more to purchase a swimsuit in the summer than in the winter. But most consumers still buy their swimsuits in the summer because that's when they need them.

Types of Price Elasticity of Demand and Examples

Price elasticity of demand is shown as a number ranging from zero to infinity. This is calculated by dividing the percentage change in quantity demanded by the percentage change in price. Each number represents a different type of elasticity and, therefore, a different type of consumer behavior.

If the quantity of a product demanded or purchased changes more than the price changes, then the product is considered to be elastic. If the change in quantity purchased is the same as the price change, then the product is said to have unit (or unitary) price elasticity. And if the quantity purchased changes less than the price, then the product is deemed inelastic.

For example, if the price goes up by 5%, but the demand falls by 10%, the product is elastic. If a price change of 10% creates a 10% change in demand, the product shows unitary elasticity. And if a price increase of 10% causes demand to fall by 5%, the product is inelastic.

Example

Suppose that the price of apples falls by 6% from $1.99 a bushel to $1.87 a bushel. In response, grocery shoppers increase their apple purchases by 20%. The elasticity of apples is thus: 0.20 ÷ 0.06 = 3.33. The demand for apples is elastic.

The Bottom Line

Price elasticity of demand is a ratio that shows how much demand for a product changes when the price of that product changes. A ratio of greater than one indicates an elastic product; a ratio of less than one indicates an inelastic product.

Economists and marketers use price elasticity of demand to understand how consumer behavior changes in response to price. The more substitutes for a product there are, the more elastic demand for it becomes. Businesses strive to create inelastic products that will retain the same level of demand even when prices increase.