Price Elasticity of Demand
Responsiveness of demand to price changes.
Formula
Variables
Example
Elastic if |E|>1
How it works
Price elasticity of demand measures how strongly buyers change the amount they purchase when a product's price changes. It is a ratio of percentage changes, so it lets you compare sensitivity across different goods even when they have very different prices or quantities. The negative relationship between price and quantity demanded is usually why the value is negative, but in practice economists often focus on the absolute size to judge how responsive demand is.
When to use it
Use this formula when you want to measure or compare how a price change affects sales for a good, service, or market. It is especially useful for pricing decisions, taxes, discounts, and studying whether customers are likely to switch away when prices rise.
Worked example, step by step
A coffee shop raises the price of a drink from $4.00 to $4.40, and weekly sales fall from 500 cups to 460 cups. Step 1: Find the percentage change in quantity: %ΔQ = (460 - 500) / 500 × 100 = -8% Step 2: Find the percentage change in price: %ΔP = (4.40 - 4.00) / 4.00 × 100 = 10% Step 3: Substitute into the formula: E_d = %ΔQ / %ΔP = -8% / 10% = -0.8 Final answer: Price elasticity of demand = -0.8, meaning demand is relatively inelastic because quantity demanded changes by a smaller percentage than price.
Common mistakes to avoid
- Using the change in quantity divided by the new quantity instead of the original quantity when finding percentages
- Forgetting that demand usually gives a negative elasticity value because price and quantity move in opposite directions
- Interpreting the raw sign alone instead of checking the size of the elasticity to judge responsiveness
Did You Know?
Price elasticity explains why cigarette taxes cut demand only slightly but luxury demand collapses.
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