price elasticity of demand
/ PED /
Price elasticity of demand answers a question every shopkeeper and tax collector cares about: if I raise the price, how much do sales actually fall? Some things people will keep buying almost regardless — petrol to get to work, medicine they depend on. Others they will drop in a flash if the price climbs — one brand of biscuit when ten others sit beside it. Price elasticity of demand puts a number on exactly how sensitive buyers are to a price change for a particular good.
The number is a ratio of percentages: the percentage change in quantity demanded divided by the percentage change in price. If a 10 percent price rise cuts sales by 25 percent, the elasticity is 25 divided by 10, which is 2.5. (Because price and quantity move in opposite directions the raw figure is negative, so people usually quote the size and drop the minus sign.) If the size is bigger than 1, demand is elastic — quantity reacts more than price. If it is smaller than 1, demand is inelastic — quantity barely reacts. Exactly 1 is called unit elastic. What makes demand elastic? Mainly having close substitutes, the item taking a big bite of your budget, it being a luxury rather than a necessity, and having plenty of time to adjust.
Knowing this number turns guesswork into strategy. A seller deciding whether to raise prices needs it: if demand is inelastic, a price rise brings in more revenue (people keep buying); if elastic, a price rise backfires as buyers flee. Governments lean on it too — they tax inelastic goods (tobacco, fuel) to raise steady money, and they know a tax on an elastic good would just kill the sales it hoped to tax. One honest caveat: elasticity is not a fixed trait of a product. It changes with the size of the price move, with how much time has passed, and with the situation — the same good can look inelastic this week and elastic next year.
Raise the price of salt by 20 percent and households barely buy less — demand is inelastic, so the seller earns more. Raise the price of one airline's economy seats by 20 percent and many flyers switch carriers — demand is elastic, so revenue can fall.
Few substitutes and a tiny budget share → inelastic. Many rivals and a big spend → elastic.
A narrowly defined good (one coffee brand) is almost always more elastic than a broad category (coffee in general), because the narrow one has close substitutes and the broad one doesn't. Always ask "elasticity of what, exactly?" before trusting a number.