Price Elasticity of Demand
The price elasticity of demand measures how quantity demanded changes with price.
Essential for pricing strategy and economics.
The Formula
Price elasticity of demand (PED) quantifies how sensitive consumers are to price changes. It is typically a negative number (price up, demand down), but is often expressed as an absolute value.
Midpoint Formula (More Accurate)
The midpoint formula gives the same result regardless of which direction the price change goes. It uses the average of the two quantities and prices as the base.
Variables
| Symbol | Meaning |
|---|---|
| PED | Price elasticity of demand (dimensionless ratio) |
| Q₁, Q₂ | Quantity demanded before and after the price change |
| P₁, P₂ | Price before and after the change |
Interpreting Elasticity
| |PED| Value | Classification | Meaning |
|---|---|---|
| |PED| > 1 | Elastic | Demand is very sensitive to price. A small price increase causes a large drop in demand. |
| |PED| = 1 | Unit elastic | Percentage change in quantity exactly equals percentage change in price. |
| |PED| < 1 | Inelastic | Demand is not very sensitive to price. Price changes have little effect on quantity. |
| |PED| = 0 | Perfectly inelastic | Quantity demanded does not change at all. Examples: life-saving medications. |
| |PED| = ∞ | Perfectly elastic | Any price increase causes demand to drop to zero. Theoretical extreme. |
Example 1
A coffee shop raises the price of a latte from $4.00 to $4.50. Daily sales drop from 200 to 170. What is the PED?
% Change in Q = (170 − 200) / ((170 + 200)/2) × 100 = −30 / 185 × 100 = −16.2%
% Change in P = (4.50 − 4.00) / ((4.50 + 4.00)/2) × 100 = 0.50 / 4.25 × 100 = 11.8%
PED = −16.2% / 11.8%
PED = −1.37 (elastic — demand is sensitive to the price change)
Example 2
Gasoline price rises from $3.00 to $3.60 per gallon. Weekly consumption drops from 15 gallons to 14 gallons.
% Change in Q = (14 − 15) / 14.5 × 100 = −6.9%
% Change in P = (3.60 − 3.00) / 3.30 × 100 = 18.2%
PED = −6.9% / 18.2% = −0.38 (inelastic — people still need to drive despite higher prices)
When to Use It
Price elasticity of demand is essential for business and economic analysis.
- Setting prices to maximize revenue (raise prices for inelastic goods, lower for elastic goods)
- Predicting the impact of taxes on consumer behavior
- Analyzing how substitutes and necessities affect demand sensitivity
- Government policy decisions on taxing goods (inelastic goods generate more tax revenue)
- Marketing strategy — understanding which customers are price-sensitive