Price Elasticity of Demand
Elasticity puts a number on how strongly quantity answers a price change: the percentage change in quantity divided by the percentage change in price. Whether that number lands above or below one decides whether a price rise raises or lowers what the seller takes in.
What a learner can do afterwards
- Compute price elasticity of demand from two points and label it elastic, inelastic or unit elastic
- Predict what happens to total revenue when an elastic good and an inelastic good each rise in price
- Give reasons a good comes out inelastic (few substitutes, small share of a budget, habit or medical need) and apply one to a real product
1 · Read
Elasticity is a number for how strongly buyers react when price moves. Divide the percent change in quantity by the percent change in price. Concert tickets rise 10 percent and sales fall 20 percent, so elasticity is 2. Above 1 means elastic, below 1 means inelastic, and exactly 1 means unit elastic. Ignore the minus sign when you label it.
Elasticity decides whether a price rise makes a seller richer or poorer. With elastic demand, the higher price drives away so many buyers that total revenue falls. With inelastic demand, buyers mostly stay, so the higher price raises total revenue. Petrol can climb without sales collapsing, while one brand of cereal cannot. Tax collectors use the same logic, taxing inelastic goods to raise money with less fuss.
What makes a good inelastic? Few substitutes, a small share of a budget, habit, or medical need. Insulin barely moves when its price rises, and commuters keep buying petrol. At the extremes, perfectly inelastic demand is a vertical line where quantity never changes, like a life-saving drug with no rival. Perfectly elastic demand is flat: any rise wipes out sales, like one potato stall among fifty identical neighbours.
Supply elasticity uses the same formula: percent change in quantity supplied over percent change in price. It measures the size of the response, not its speed. Time still matters: farmers cannot grow extra wheat overnight, while a factory with idle machines can do more. Both sides together show who feels a price shock.
Divide the two percent changes, label the number against 1, and read revenue off the label.
The readings Measuring responses to price, Price changes and revenue, and The limits of demand response were written for this dataset. The reading Price elasticity of demand and price elasticity of supply is based on material from Khan Academy.
More to read
Measuring responses to price
To calculate price elasticity of demand, divide the percentage change in quantity demanded by the percentage change in price. Report the magnitude of the result. A 10 percent ticket-price increase with a 20 percent sales decrease gives elasticity 2. Values above 1 indicate elastic demand; below 1, inelastic demand; and 1, unit elasticity. If insulin sales barely change after a 10 percent price rise, demand is inelastic. For supply elasticity, divide the percentage change in quantity supplied by the percentage change in price. Both measure response size, not response speed.
Price changes and revenue
Demand elasticity helps predict changes in total revenue, not profit. With elastic demand, a price increase reduces purchases enough to lower revenue. With inelastic demand, revenue rises instead. Petrol demand is often less responsive than demand for a particular cereal brand, whose buyers can switch brands. Sellers use this information when choosing prices. Taxes on inelastic goods can raise revenue while causing a smaller reduction in purchases.
The limits of demand response
A vertical demand curve represents perfect inelasticity: price changes leave quantity unchanged. A lifesaving medicine without substitutes may approach this case in the short run. Perfect elasticity gives a horizontal curve; raising price above the market price eliminates sales. A potato stall competing with fifty neighbours selling identical goods may approximate it. Some curves have constant elasticity throughout. Most real demand falls between the extremes, which help interpret elasticity values.
Price elasticity of demand and price elasticity of supply
Demand elasticity and supply elasticity are siblings with different personalities. Demand elasticity asks how buyers flinch when prices change, and it depends on substitutes, necessity, and time to adjust. Supply elasticity asks how much producers respond, which depends on spare capacity and the time they have to adjust. Both use the same percent change formula, which keeps comparisons fair across cheap and pricey goods. Farmers cannot grow extra wheat overnight, so short run farm supply is inelastic, while a factory with idle machines can raise output more. Knowing both sides tells you who really feels a price shock.
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8 questions wait behind this lesson, each with its answer explained. Every answer feeds the sky: stars light as they are learned, and dim when it is time to come back.