Glossary term
Price Elasticity of Demand (PED)
Price elasticity of demand measures how much quantity demanded changes when the price of a good or service changes.
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What Is Price Elasticity of Demand?
Price elasticity of demand, or PED, measures how much quantity demanded changes when the price of a good or service changes. It helps explain whether buyers are highly sensitive to price or relatively insensitive.
If a small price increase causes demand to fall sharply, demand is elastic. If demand changes only slightly, demand is inelastic. Businesses, investors, and policymakers use the concept to understand pricing power, revenue risk, taxes, and consumer behavior.
Key Takeaways
- Price elasticity of demand measures demand sensitivity to price changes.
- Elastic demand means quantity demanded changes more than proportionally.
- Inelastic demand means quantity demanded changes less than proportionally.
- The concept affects pricing strategy, revenue forecasts, taxes, and inflation analysis.
Formula
The basic formula compares the percentage change in quantity demanded with the percentage change in price.
In this formula, the numerator is the percentage change in quantity demanded, and the denominator is the percentage change in price. Economists often focus on the absolute value when describing demand as elastic or inelastic.
Demand Type | Typical Meaning |
|---|---|
Elastic demand | Quantity demanded changes strongly when price changes. |
Inelastic demand | Quantity demanded changes only modestly when price changes. |
Unit elastic demand | Quantity demanded changes proportionally with price. |
Perfectly inelastic demand | Quantity demanded does not change with price in the model. |
What Shapes Elasticity
Demand tends to be more elastic when buyers have many substitutes, the purchase is discretionary, the price is a large share of the budget, or consumers have time to adjust. Demand tends to be less elastic when the product is essential, substitutes are limited, or switching is difficult.
Elasticity can also change over time. Gasoline demand may be inelastic in the short run because people still need to drive, but more elastic over longer periods as buyers change vehicles, routes, jobs, or housing.
Revenue and Pricing Effects
Elasticity helps explain why price increases do not always raise revenue. If demand is elastic, a price increase can reduce quantity enough to lower total revenue. If demand is inelastic, a price increase may raise revenue because quantity falls by less.
Investors use this logic when evaluating pricing power. A company with inelastic demand may be better able to pass through cost increases, while a company with elastic demand may lose customers quickly when prices rise.
The Bottom Line
Price elasticity of demand measures how responsive buyers are to price changes. It is a core tool for understanding pricing power, consumer behavior, taxes, and revenue risk.