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 $|\varepsilon|$. When $|\varepsilon| > 1$ the good is elastic — buyers are sensitive and quantity shifts more than proportionally. When $|\varepsilon| < 1$ it is inelastic — buyers are relatively unresponsive. When $|\varepsilon| = 1$ 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.