Price Elasticity of Demand

DEFINITION: The “price elasticity of demand”—sometimes shortened to just “elasticity of demand”—refers to a metric that measures the way in which changes in the unit price of a product affect changes in demand for the product (consumption).

Mathematically, price elasticity of demand may be defined as follows:

Price Elasticity of Demand = Percentage Change in Quantity Demanded ÷ Percentage Change in Unit Price

This formula just represents the intuitively obvious fact that as the unit price of a product decreases, demand for the product increases, other things being equal, and vice versa.

The psychological principle of human nature underlying the formula is the fact that buyers love a bargain.

ETYMOLOGY: The English word “price” derives from Middle English “pris,” which in turn derives from Old French and, ultimately, from the Latin noun pretium (“money,” “price”).

The English abstract noun “elasticity” is first attested from the mid-seventeenth century. It derives, of course, from the adjective “elastic,” which derives from the New Latin elasticus. The Latin adjective, in turn, derives from Late Greek elastos, meaning “beaten” or “ductile,” a past participle from the verb elaunō, elaunein, meaning “drive” or “to set in motion” in classical Greek, and “to beat out” in Late Greek.

The English noun “demand,” which is attested from the fourteenth century, derives, of course, from the related verbal homonym. The latter derives from Middle English demaunden, which may be traced back through Middle French demander and Medieval Latin demando, demandare, meaning “entrust” or “commit.”

USAGE: In addition to demand, supply possesses its own elasticity, called, naturally enough, the “price elasticity of supply.”

The same formula that applies to the price elasticity of demand applies to this metric, as well:

Price Elasticity of Supply = Percentage Change in Quantity Supplied ÷ Percentage Change in Unit Price

This equation represents the intuitively obvious fact that as the supply of a product increases, its unit price decreases, other things being equal, and vice versa.

The psychological principle underlying this formula is the fact that sellers do not want to be stuck with unsold inventory.

Economists commonly take both of these metrics into consideration when they are attempting to prospectively determine (or retrospectively explain) which goods will be produced at what unit price.

However, since the two equations are mathematically identical, we can just as well focus on the price elasticity of demand alone for present purposes.

Price Inelasticity

One of the most interesting discoveries that economists have made in exploring the price elasticity of demand is that not all goods are created equal. Rather, certain goods exhibit high price inelasticity.

The “price elasticity” of a given product means that changes in its unit price do not affect demand for the product in the ways in which that one would have expected.

Another way of putting the same point is to say that, no matter whether the price of the product in question goes up or down, the amount of it demanded remains about the same.

For example, take the case of gasoline, diesel, jet fuel, and other similar fuel products. Individual automobile owners, long-haul truck drivers, and the airline companies continue to purchase the fuel they require in about the same quantities, regardless of any fluctuations in price, either up or down.

Certain goods, on the other hand, display an unusually high degree of elasticity, leading to significant shifts in demand in response to even modest price changes.

In short, a product is considered elastic if the demand point shifts significantly from its initial position in response to variations in its price.

Conversely, if the quantity doesn’t deviate from its previous point very much following a change in its price, the product is considered inelastic.

Unsurprisingly, the elasticity of demand holds great interest for marketing professionals. In fact, creating inelastic demand for the products they promote might be viewed as their primary purpose.