What is Price Elasticity?
Price elasticity of demand measures how sensitive the quantity demanded of a good is to a change in its price. It tells businesses and economists whether raising or lowering a price will help or hurt total revenue.
Price elasticity of demand (Ed) equals the percentage change in quantity demanded divided by the percentage change in price. |Ed| > 1 means demand is elastic; |Ed| < 1 means it is inelastic.
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Step-by-step worked examples
Coffee's price rises from $4 to $5 and quantity demanded falls from 100 to 80 cups. Find Ed.
%ΔQ = (80-100)/100 = -20% %ΔP = (5-4)/4 = +25% Ed = -20% / 25% = -0.8 → |Ed| < 1, demand is inelastic
A designer bag's price rises 10% and quantity demanded falls 30%. Find Ed.
%ΔQ = -30% %ΔP = +10% Ed = -30/10 = -3 → |Ed| > 1, demand is elastic (luxury good)
Salt's price rises from $2.00 to $2.20 and quantity demanded falls from 500 to 495 units. Find Ed.
%ΔQ = (495-500)/500 = -1% %ΔP = (2.20-2.00)/2.00 = +10% Ed = -1/10 = -0.1 → very inelastic (necessity, few substitutes)
Flashcards
Quick quiz
Q1.Price rises 20%, quantity demanded falls 40%. What is Ed?
Q2.Which good is typically most inelastic?
Q3.If |Ed| = 1, demand is called:
Q4.A price increase on an elastic good will typically:
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Common mistakes
Ignoring the negative sign and confusing elastic with inelastic. — Correct: Always check the absolute value: |Ed| > 1 elastic, |Ed| < 1 inelastic.
Using the wrong base in percentage change calculations. — Correct: Percentage change = (new - old) / old, always divide by the ORIGINAL value.
Assuming all goods have the same elasticity. — Correct: Elasticity depends on substitutes, necessity vs luxury, and time horizon.
Thinking elasticity is constant along a straight-line demand curve. — Correct: Elasticity actually varies at different points along a linear demand curve.
FAQ
What is price elasticity of demand?
It's a measure of how much quantity demanded changes in response to a price change, calculated as %ΔQd / %ΔP.
What is the elasticity formula?
Ed = (percentage change in quantity demanded) / (percentage change in price).
How do you calculate price elasticity?
Find the percentage change in quantity demanded and divide it by the percentage change in price, then compare the absolute value to 1.
What are examples of elastic vs inelastic goods?
Luxury goods and goods with many substitutes (designer bags, restaurant meals) are elastic; necessities with few substitutes (salt, insulin, gasoline short-term) are inelastic.