econ.studio

Glossary term

Price Elasticity of Demand

How sharply quantity demanded responds to a price change. The number that tells you whether a price cut raises or lowers revenue, why salt is inelastic and a single cereal brand is elastic, and what determines responsiveness.

Glossary

Price Elasticity of Demand

When a price changes, buyers do not always react the same way. Sometimes they barely adjust — a streaming service raises its monthly fee by 15 percent and almost nobody cancels. Other times they react a lot — one brand of cereal gets pricier and shoppers immediately grab the box next to it. Price elasticity of demand is the number that captures how big that reaction is.

Formally, elasticity is the ratio of two percentage changes: the percentage change in quantity demanded divided by the percentage change in price. Because demand slopes downward, a price increase produces a quantity decrease, so the raw value is negative. Economists therefore report the absolute value ∣ε∣|\varepsilon|. When ∣ε∣>1|\varepsilon| > 1 the good is elastic — buyers are sensitive and quantity shifts more than proportionally. When ∣ε∣<1|\varepsilon| < 1 it is inelastic — buyers are relatively unresponsive. When ∣ε∣=1|\varepsilon| = 1 demand is unit elastic and the two percentage changes are equal. Four factors govern where a good falls: the availability of close substitutes (the cereal example), whether the good is a necessity or a luxury, how large a share of your budget it consumes, and the time horizon you are considering.

ε=% ΔQd% ΔP\varepsilon = \frac{\%\,\Delta Q_d}{\%\,\Delta P}
Price elasticity of demand
Elasticity is the ratio of two percentage changes. The total-revenue test follows directly: if demand is elastic (∣ε∣>1|\varepsilon| > 1), a price cut raises total revenue because the quantity gain outweighs the lower price; if demand is inelastic (∣ε∣<1|\varepsilon| < 1), a price cut lowers total revenue.
Elastic demand
Demand where ∣ε∣>1|\varepsilon| > 1: a 1 percent price change causes a greater than 1 percent change in quantity demanded. Common when close substitutes are available.
Inelastic demand
Demand where ∣ε∣<1|\varepsilon| < 1: buyers change quantity less than proportionally when price changes. Typical of necessities and goods with few substitutes.
Unit elastic
The special case ∣ε∣=1|\varepsilon| = 1, where the percentage change in quantity exactly equals the percentage change in price, leaving total revenue unchanged.
Cross-price elasticity of demand
The percentage change in the quantity demanded of one good divided by the percentage change in the price of a different good. A positive value indicates substitutes; a negative value indicates complements. See also demand.