Price Elasticity Explorer

Price Elasticity of Demand measures how responsive consumers are to a change in price. It is calculated as the percentage change in quantity demanded divided by the percentage change in price.

Elastic demand (|Ed| > 1): Consumers are very responsive to price changes. A small price increase leads to a large drop in quantity demanded. Total revenue falls when price rises.

Inelastic demand (|Ed| < 1): Consumers are not very responsive. Price increases lead to small drops in quantity demanded. Total revenue rises when price rises.

Unit elastic (|Ed| = 1): Revenue is maximized at this point. The percentage change in quantity exactly offsets the percentage change in price.

Determinants of Elasticity

• Availability of substitutes: More substitutes = more elastic. Designer handbags have many alternatives; insulin does not.
• Necessity vs. luxury: Necessities (gasoline, insulin) tend to be inelastic. Luxuries (designer handbags) are elastic.
• Time horizon: Demand becomes more elastic over time as consumers find alternatives.
• Budget share: Goods that take a larger share of income tend to be more elastic. A 50% increase in the price of a car matters more than a 50% increase in the price of salt.
• Definition of the market: Narrower markets (Coca-Cola) are more elastic than broader markets (soft drinks).

Revenue and Elasticity

The relationship between price changes and revenue depends entirely on elasticity:

• If demand is elastic: raising price decreases revenue (quantity drops a lot).
• If demand is inelastic: raising price increases revenue (quantity drops only a little).
• Revenue is maximized where demand is unit elastic (|Ed| = 1).