Price Elasticity of Demand

Reviewed by Bhavana | Updated on Aug 27, 2020

Definition

The price elasticity of demand is an economic indicator of the increase in the quantity a commodity demands or consumes in relation to its change in price.

Economists use price elasticity to explain how supply or demand changes and understand the workings of the real economy, despite price changes. For example, certain goods are rather inelastic, that is, their prices don't change much given the changes in demand or supply, for example, individuals need to buy fuel to get to work or fly around the world, and even if oil prices increase, people are likely to purchase exactly the same amount of gas still. On the other hand, other commodities are very dynamic, causing drastic changes in their demand or supply due to their price changes.

How is it Expressed Mathematically?

Price Elasticity of Demand = % Change in Quantity Demanded / % Change in Price

Lets Understand Price Elasticity of Demand in Detail

If a product's requested quantity experiences a substantial shift in response to price increases, it is called "elastic," i.e. quantity extended far from its preceding level. If the purchased quantity has a slight change in response to its size, it is called "inelastic;" or quantity has not extended dramatically from its preceding level.

The easier a shopper can replace one product with a rising price for another, the more the price will drop – be "elastic." In other words, in a world where people like coffee and tea equally, if the price of coffee goes up, people will have no problem switching to tea, and so the demand for coffee will drop. That is because coffee and tea are seen as good alternatives to each other.

The more discretionary a transaction is, the higher the elasticity, the more the quantity will decrease in response to price increases. So, if you're considering purchasing a new washing machine, but the existing one is still working (it's just old and outdated), and if the costs of new washing machines are rising, you're likely to skip the immediate purchase and just wait until prices go down or when the existing machine is dropping.