Price Elasticity of Demand

Price Elasticity of Demand

The measure of how the quantity demanded of a good responds to changes in its price, calculated as percent change in quantity over percent change in price.

Elasticity

When the quantity demanded of a good or service significantly responds to changes in price.

Inelasticity

When the quantity demanded changes very little with a change in price, indicating less consumer responsiveness to price fluctuations.

Coefficient < 1

Indicates inelastic demand.

Coefficient > 1

Indicates elastic demand.

Determinants of Price Elasticity of Demand

Factors that affect the elasticity of demand including substitutes, time frame, income share, luxury versus necessity, and narrowness of market.

Substitutes

More substitutes lead to greater elasticity; fewer substitutes lead to more inelasticity.

Time Frame

Longer time frames increase elasticity; shorter time frames result in more inelastic demand.

Income Share

Higher income share indicates elastic demand; lower income share indicates inelastic demand.

Luxury vs Necessity

Necessities are inelastic (e.g., insulin), while luxuries are elastic.

Narrowness of Market

Markets with narrow definitions (e.g., market for apples) are more elastic; broad markets (e.g., food) tend to be inelastic.

Perfect Elasticity of Demand

Occurs when the coefficient equals infinity, indicating a horizontal demand curve that responds significantly to price changes.

Perfect Inelasticity of Demand

Occurs when the coefficient equals zero, indicating a vertical demand curve with no change in quantity regardless of price changes.

Constant Unit Elasticity

Occurs when the coefficient equals 1, indicating that percentage changes in quantity demanded are exactly equal to percentage changes in price.

Total Revenue and Elasticity

Describes the relationship between price changes and total revenue; if price and total revenue are directly proportional, demand is inelastic.

Unit Elastic Demand

When total revenue remains constant despite price changes.