Price Elasticity of Demand
IntermediatePrice elasticity of demand measures how strongly the quantity of a good that people buy responds to a change in its price.
Elasticity compares the percentage change in quantity demanded with the percentage change in price. If a small price rise causes a large fall in purchases, demand is elastic. If purchases barely change, demand is inelastic.
Suppose a café raises the price of coffee from 4.00 to 4.40, about a 10% increase, and weekly sales fall from 1,000 to 920 cups, about an 8% decrease. The elasticity is roughly −0.8. Because the figure is less than 1 in absolute size, demand is inelastic: sales fell, but proportionally less than the price rose. The café's revenue actually rises, from 4,000 to 4,048 a week.
Demand tends to be more elastic when close substitutes exist, when the product takes up a large share of a budget, when it is a luxury and over longer periods, as people have time to adjust. Essential medicines and fuel in the short term tend to have inelastic demand. A particular brand of soft drink tends to have elastic demand.
Elasticity helps businesses set prices and helps governments predict how taxes will affect consumption and revenue.
For worked examples and full lessons, visit notesbysara.org.