Definition: Price Elasticity of Demand is a macroeconomic term that measures the correlation between a change in demand and a change in price for a product or service. In other words, it shows how a change in the price of a product will affect the overall demand for the product.
What Does Price Elasticity of Demand Mean?
Demand for a product can range from elastic to inelastic. Demand is considered more elastic the more a change in price affects the amount desired. Demand is considered more inelastic the less a change in price affects the amount desired.
In other words, the more elastic the demand is, the more the price will affect the demand. For instance, a price increase of an elastic product would decrease the demand for it. Inelastic products’ demand, on the other hand, is not affected by price. If the price were increased on these products, the demand would remain the same.
Elasticity can be perfectly inelastic or perfectly elastic or anywhere in between; however, the two extremes rarely occur in the real world.
Let’s look at an example.
Tom is a storeowner who wants to know how much he can charge for his newest product, so he use price elasticity formula to see what will happen if he changes the price from $9.00 to $10.00
Formula: Percent change in Quantity Demanded over Percent change in Price.
If at $9.00 his customers requested 150 units and at $10.00 they only requested 110 units, he would first find the change in demand: -.267. The percentage change in price is .11. Plugging each value into the formula he would get around -2.4. Both of these figures are then converted into absolute values. In this case, the demand was elastic because the value was greater than 1. In other words, the more Tom raises prices, the less his customers are willing to purchase. Tom has to figure out where the sweet spot is between raising prices and losing customers to maximize profits.
Elasticity is the measure of the demand curve and it’s response to price. The more influenced by price, the more elastic, meaning the price willing to be paid will not deviate very much from the average. A small increase in price may cause quantity demanded to decrease by a large amount and a small decrease in price may cause quantity demanded to increase by a large amount. Inelasticity occurs when demand for a good or service isn’t as influenced by price. This is most commonly seen with necessities such as water. If the price of water skyrocketed, people would simply have to adjust because the demand for water will not really change; it is not as if anyone could simply say they no longer need it even if the price increased.
If the price elasticity is >1 it is elastic, equal to 1 means unit elastic (1 unit change in price means 1 unit change in demand), and <1 means demand is inelastic.