How To Calculate Price Elasticity Of Demand (With Examples)

Every product on the market has its fluctuations in demand. Understanding a product’s demand is crucial for setting an appropriate price point and making sales.

Many businesses struggle to define the price of their product because even the slightest miscalculation sends consumers running in the other direction. That’s the battle of price elasticity of demand.

What Is Price Elasticity of Demand?

Price elasticity of demand refers to how much a product’s price impacts a customer’s demand for it. Everyone has their price limits when it comes to certain services. Price elasticity is defined as the sensitivity of customers as a whole when it comes to price shifts.

For example, consider gasoline in the United States. When the price goes up, people may groan and complain, but they’re still going to fill their tank and drive to work. This is because gasoline is an extremely inelastic good.

Alternatively, consider a soda company that provides a generic copy of Coca-cola. If they were to start charging double the average price for their drink suddenly, everyone would stop purchasing it. They would drink a different brand of soda because there are so many substitutes available. This is an example of an elastic product.

Factors That Affect a Product’s Elasticity of Demand

A business ideally wants to sell a good that isn’t too elastic because it gives them more control in the market, but it isn’t really up to them. Several factors contribute to a product’s elasticity, or inelasticity, of demand.

The main factors that impact a product’s elasticity of demand include the following.

1. Necessity vs. luxury. The first aspect of a good that influences its level of elasticity is whether it is a necessity or a luxury. An item that is a necessity means that people cannot live without it. People are more willing to buy it, even if the price goes up.

   These products are more inelastic when it comes to their demand in comparison to price changes.

   Examples of necessities include:

   • Textbooks for college

   • Gasoline

   • Plane tickets

   • Medical procedures (in the United States)

   • Meat and dairy

   On the other hand, luxury products are things that might make us happy or our lives more comfortable, but we don’t need them. When these items go up in price, we’re more likely to stop purchasing them because it’s just an extra.

   Examples of luxuries include:

   • Jewelry

   • Excessive clothing

   • Alcohol

   • Electronics, like televisions

   These items are considered to have a high elasticity of demand because while we enjoy them, they’re not vital.

2. Available vs. scarce. A product’s general availability to the public is another factor that impacts its elasticity of demand. This mostly has to do with the availability of substitutes on the market.

   When an item is the type of good that can easily be replaced with another supplier, it will have a much higher elasticity of demand because there’s no reason to stick around when the price rises.

   An excellent example of a scarce type of item would be a concert ticket to a particular artist. Since nobody else could give this person’s performance, the tickets to the event have an extremely low elasticity of demand.

   Even if they’re charging hundreds of dollars, people provide the demand because they want this scarce experience. There are no substitutes available.

   Alternatively, if a pizza place opened up, charging $50 for one slice, it would quickly be met with low demand. This is because there a hundred other pizza joints within 10 miles of the location, so customers are more sensitive to price fluctuations.

3. High income vs. low income. An elasticity of demand factor impacted by a product’s geographical locations and customer base is high income versus low income. An item that’s marketing to a wealthier group of people, such as a luxury clothing line, has a lower elasticity of demand because the customer base has more disposable income.

   They’re not as affected by an increase in price because the purchase takes up a smaller percentage of their total income.

   On the flip side, goods sold in an area or to customers with statistically lower income have a higher elasticity. This is because buying a product takes up more of their income, which they need for other things. When an item has a sharp price increase, people are more likely to turn away.

How Businesses Use Price Elasticity of Demand

When a business specializes in a particular product, its elasticity of demand is of the utmost importance. It could mean the difference between a company succeeding or lacking in customers.

Take a jewelry store, for instance. If they start selling their rings 15% over the current market value, they experience a corresponding drop in ring sales of 7%. This means that their rings are elastic products.

However, if the only tire store within an hour of a small town starts putting a 5% markup on their inventory, their sales will likely remain unchanged because people need the service, and it’s not widely available.

Calculating an item’s elasticity helps you understand how consumers are going to react to particular price moves. This helps companies make educated decisions about their product’s pricing.

How Is Price Elasticity of Demand Calculated?

Decimals quantify the elasticity of demand. After calculating a product’s elasticity, it provides a positive or negative decimal. An answer below 1, including negative numbers, would be considered inelastic because there is less demand for a price increase.

A final answer that is over one would be considered elastic because the product is losing more sales with a price increase.

If you’re curious about how to calculate a good’s price elasticity of demand, follow these steps.

1. Review the formula. The first step to solving any big or small math problem is reviewing the formula. When solving for an item’s price elasticity of demand, the formula is:

   Price Elasticity of Demand = Percentage Change in Quantity Sold / Percent Change in Price

   While that looks a little confusing at first, it’s easy once you understand all the terms.

2. Find the percentage change in price. To begin, find the percentage change in the item’s price. This means how much it changes from the original cost as a percentage. This is found by dividing the difference in prices from the original price.

   For example:

   An ice cream shop sells vanilla cones that originally cost $4.00, but the price went up to $5.00. There is a difference of $1 between these two prices, so you would divide one by the original cost of $5.00.

   ⅕=0.2

   This decimal value is multiplied by 100 to get a percentage change in the price of 20%.

3. Find the percentage change in quantity sold. The next step in discovering an item’s elasticity is finding the percentage change again, but this time for the quantity sold.

   To do this, find the difference between the original amount of goods sold and how many were sold after the price change. Then, you divide this value by the original amount of goods sold.

   This results in another decimal that’s multiplied by 100 to get a percentage change rate.

   Continuing with the previous example of the ice cream store, they originally sold 200 vanilla ice cream cones every day. After the price change, they sold 150 ice cream cones per day on average.

   First, they find the difference between the original and post-price increase quantity, which is 50. This value is divided by the original amount of ice cream cones sold, which is 200.

   50/200 = 0.25

   This value is multiplied by 100 and ends with a percentage change rate of 25%.

4. Divide the percentage change in quantity by the percentage change in price. Now that you have all the values you need to solve for price elasticity of demand, simply plug them into the original formula to answer.

   With the ice cream store example, they find their final elasticity by dividing the percentage change of quantity by the percentage change of price that was already found.

   25/20 = 1.25

   Since this result is higher than 1, then the ice cream store’s vanilla cones would be considered an elastic good.

Author

Sky Ariella

Sky Ariella is a professional freelance writer, originally from New York. She has been featured on websites and online magazines covering topics in career, travel, and lifestyle. She received her BA in psychology from Hunter College.