Price elasticity of demand

Price elasticity of demand (PED) quantifies buyer sensitivity to price. The formula is PED = % change in quantity demanded ÷ % change in price. Because demand curves slope downward, the result is normally negative, so economists usually discuss its absolute value. A value greater than 1 means demand is elastic — quantity responds more than proportionately to price. A value less than 1 means demand is inelastic, and a value of exactly 1 is unit elastic.

For example, if a 10% price increase causes quantity demanded to fall 25%, PED is −2.5, or elastic in absolute terms. If the same 10% increase causes only a 4% fall, PED is −0.4 and demand is inelastic. Elasticity depends on how easily buyers can substitute away, whether the good is a necessity or a luxury, how large a share of income it consumes, and how much time buyers have to adjust — demand is almost always more elastic over the long run than the short run.

Elasticity determines what happens to total revenue when price changes. Where demand is inelastic, raising price increases total revenue because the quantity lost is proportionally smaller than the price gain. Where demand is elastic, raising price reduces total revenue. This is why firms with few substitutes for their product — utilities, patented medicines, addictive goods — can raise prices with limited volume loss, while a producer in a competitive commodity market cannot. Governments apply the same logic when choosing goods to tax.

Related measures extend the idea: income elasticity of demand tracks response to changes in income, and cross elasticity of demand tracks response to a change in the price of another good, distinguishing substitutes from complements. The CIMA Certificate in Business Accounting (BA) syllabus covers price elasticity within the market system, expecting you to compute it, classify demand as elastic or inelastic, and predict the revenue effect of a price change.