Price Elasticity of Demand
What is Price Elasticity of Demand?
Price elasticity of demand measures how responsive quantity demanded is to a change in the good's price.
It is the percentage change in quantity demanded divided by the percentage change in price. Demand is elastic when the absolute value is greater than 1 and inelastic when it is less than 1. Goods with many substitutes, that take a large share of income, or judged over a longer time horizon tend to be more elastic.
Price Elasticity of Demand: a worked example
A coffee shop raises the price of a latte from $4 to $6 and weekly sales fall from 100 to 60. By the midpoint method the percentage change in quantity is (60 − 100) ÷ 80 = −50% and the percentage change in price is (6 − 4) ÷ 5 = +40%, so PED = −50 ÷ 40 = −1.25, elastic in absolute value. The revenue test agrees: revenue falls from $400 to $360, which is what happens when price rises on elastic demand.
The mistake students make with price elasticity of demand
Students judge elasticity by how steep the demand curve looks and assume a straight-line demand curve carries one elasticity along its whole length. Slope and elasticity are not the same thing: along a straight-line demand curve the slope is constant, but elasticity falls continuously from greater than 1 near the top, through exactly 1 at the midpoint, to less than 1 near the bottom, because elasticity is built from percentage changes and the base price and quantity keep changing as you move along the curve.
Price Elasticity of Demand questions
Is demand elastic or inelastic if the price elasticity of demand is 0.5?
A price elasticity of demand of 0.5 means demand is inelastic, because the absolute value is below 1 and quantity demanded therefore changes by a smaller percentage than price. A 10% price increase would cut quantity demanded by only about 5%.
Why is price elasticity of demand negative?
Price elasticity of demand is negative because price and quantity demanded move in opposite directions under the law of demand, so the numerator and denominator of the ratio carry opposite signs. Economists usually report the absolute value, which is why a coefficient is quoted as 1.25 rather than −1.25.
What happens to total revenue when price rises and demand is elastic?
Raising price when demand is elastic lowers total revenue, because quantity demanded falls by a larger percentage than the price rises. A seller facing elastic demand raises revenue by cutting price instead.
Formula / Example
This is the live Elasticity sandbox. Drag the curves, or open the full version.
Related terms
The same idea in another course
Why elasticity has no unitsElasticity is one relative rate of change divided by another, and dividing two percentages is what cancels the units away. On CalcLearn, a sister site.
Common comparisons
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