How to Calculate Price Elasticity of Demand

Price elasticity of demand measures how the demand for a good or service is affected by fluctuations in the price. When a price change has a small effect on the quantity demanded, economists consider a good to be inelastic. When a price change has a large effect on the quantity demanded, a good is elastic.

Knowing the elasticity or inelasticity of a product is valuable for determining whether to set higher or lower prices or to make a small change in price or a large change in price. Price elasticity of demand is just one part of how economists and businesses comprehend how supply and demand for goods change due to price decreases or increases.

To solve for the price elasticity of demand (PED), use the following equation to find the elasticity coefficient:

For example, say that the price of a movie ticket increases by 20 percent from $12 to $15. As a result of the price increase, moviegoers decrease movie ticket purchases by 35 percent.

To find the PED for movie tickets, calculate: -0.35 ÷ .20 = -1.75

Price elasticity focuses on the absolute value, so you can ignore the negative sign. If the absolute value of PED is greater than one, the price is elastic. In this case, the elasticity coefficient is 1.75, which determines that movie tickets are an elastic good.

The following terms will help you interpret your elasticity coefficient answer.

• Inelastic demand: A coefficient answer less than 1 means the product has inelastic demand. Inelastic demand indicates that the product's demand changes less than the price changes. When a product is inelastic, it signals that revenue rises when you increase the price and revenue falls when you decrease the price.
• Elastic demand: PED greater than 1 means the product has elastic demand. Elastic demand indicates that the product's demand changes more than the price changes. When a product is elastic, it signals that revenue falls when you increase the price and rises when you decrease the price.
• Unitary elastic demand: Exactly 1 means the product has unitary elastic demand. Demand is unit elastic when the product's demand changes in proportion to the change in price. When a product has unitary elastic demand, it signals that revenue stays constant no matter how much you increase or decrease the price.
• Perfectly inelastic: Exactly 0 means the product is perfectly inelastic. Perfectly inelastic demand indicates that the product's demand will stay exactly the same no matter how much the price changes. Perfectly elastic products are typically survival necessities because consumers will continue to buy them no matter how high the price. If you lower the price of a perfectly inelastic product, revenue will decrease significantly.
• Perfectly elastic: Infinite (∞) means the product is perfectly elastic. Perfectly elastic demand indicates that the product's demand will fall to zero if the price increases at all. Perfectly elastic products typically have a predetermined set value.

A company typically benefits when its products are as inelastic as possible, so it can raise prices without decreasing demand. Before selling a product at a different price, consider the following determinants for price elasticity of demand.

1. 1. Availability of substitutes: Goods are more elastic when it's easier for consumers to replace the good with a comparable substitute. The less competition a product has, the more inelastic it will be.
2. 2. Necessity: The more necessary a good is, the more inelastic it is because consumers find it difficult to survive without it. Examples of inelastic necessary goods include gasoline, electricity, and many medications. More frivolous luxury items, like vacations or restaurant meals, are easier for consumers to pass up when they get too expensive.
3. 3. Duration of the price change: The longer a price change is in effect, the more elastic a good becomes because consumers have a greater incentive and period of time to seek out a substitute. The most notable example of this is gasoline because in the short run gasoline is quite inelastic. When gas prices initially rise, people still need to get around in their vehicles so they reluctantly pay the higher price and continue to fuel up as usual. However, if gas prices were to stay extremely high for a long period of time, the gas would become a more elastic good. Consumers might decide it's worth it to buy an electric car, take public transportation, or ride their bike instead of using a gas-powered vehicle.
4. 4. Percentage of consumer's income: Goods become more elastic when the cost of the good is a higher percentage of the consumer's income.

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