Price elasticity of demand measures how much a product’s consumption changes in response to price changes. Mathematically speaking, it is

Price Elasticity of Demand = Percentage Change in Quantity Demanded / Percentage Change in Price

Ed (p) = % ΔQd / %ΔP

(OR)

Midpoint Method

Price elasticity is a tool used by economists to analyse how supply and demand for a product fluctuate in response to price changes. Price elasticity of demand measures how much a product’s consumption changes in response to price changes. A good is elastic if a price change results in a significant shift in either supply or demand. If a price change for a good does not significantly affect demand or supply, it is inelastic. The elasticity of a product is impacted by the accessibility of a substitute. Demand won’t change as the price increases if the product is necessary and there are no suitable alternatives, making it inelastic.

The pricing of some products are particularly inelastic, according to economists.

In other words, neither a price decrease nor an increase in price significantly affect demand. For instance, the price-elasticity of demand for fuel is low. Drivers, as well as airlines, the trucking industry, and practically every other consumer, will continue to make as many purchases as necessary. Since the price elasticity of other products is substantially higher, changes in their price have a significant impact on either their supply or demand.

It is not unexpected that marketing experts are really interested in this idea. Even so, it may be argued that their main objective is to increase inelastic demand for the goods they promote. They accomplish this by identifying a significant distinction between their goods and any others on the market.

A product is elastic if, in reaction to price changes, the quantity requested of it changes significantly. In other words, the product’s demand point has greatly expanded from its previous point. It is inelastic if the quantity purchased changes only slightly when the price changes. The quantity barely changed from its starting point.

A purchase’s amount of demand will decrease in response to price rises the more discretionary it is. In other words, the product demand is more elastic. Let’s say you are debating purchasing a new washing machine, but the one you already own is still functional despite being dated. If the cost of a new washing machine increases, you can decide against making the purchase right away and instead hold off until the price drops or the old machine malfunctions.

A product’s quantity demand will decline less the less discretionary it is. Luxury goods that people purchase because of their brand names are an example of an inelastic example. Both addictive products and necessary add-on items, like ink-jet printer cartridges, are very inelastic. All of these products share the disadvantage of having poor substitutes. A Kindle Fire won’t do if you actually want an Apple iPad. Higher costs do not deter addicts, and only HP ink is compatible with HP printers (unless you disable HP cartridge protection).

The duration of the price change is also important. For a price adjustment that lasts for a season or a year, the demand response is different than it is for a one-day sale. To comprehend the price elasticity of demand and to compare it with other items, temporal sensitivity must be clearly defined. Consumers could be willing to put up with a seasonal price shift rather than changing their routines.

Example of Price Elasticity of Demand:

As a general rule, a product is deemed elastic if the amount required or purchased fluctuates more than the price changes. (For example, suppose the price rises by 5% but demand reduces by 10%.) If the change in quantity purchased equals the change in price (say, 10% /10% = 1), the product is said to have unit (or unitary) price elasticity. Finally, if the quantity purchased varies less than the price (for example, -5 percent demanded for a +10 percent price shift), the commodity is considered inelastic.

What Causes a Product to Be Elastic?

A product is deemed elastic if a price change produces a significant change in  demand. In general, it signifies that the product has suitable replacements. Cookies, fancy autos, and coffee are a few examples.

What Causes a Product to Be inelastic?

A product is called inelastic if a price change causes little or no change in its  demand. In general, it signifies that the product is a need or a luxury item with addictive components. Gasoline, milk, and iPhones are all examples.

Types of Price Elasticity of Demand:

There are three types of price elasticity of demand. They are:

1) Inelastic Demand

2) Elastic Demand

3) Unitary Demand

1) Inelastic Demand:

Inelastic demand occurs when the price elasticity of demand is less than one, indicating that customers are mainly unresponsive to price changes. For example, 100 buyers may purchase a Ferrari for $200,000 each. If Ferrari raises its pricing to $250,000 and only 99 people buy it, the product is incredibly inelastic. This is because buyers do not place a high value on pricing.

Inelastic demand can emerge due to a scarcity of substitute items. A local grocery, for example, may only sell one sort of bread. Because the only other option is kilometres away, there may be an opportunity cost. To obtain a comparable goods, the consumer must spend time and money on transportation. As a consequence, the store may be able to raise prices significantly before consumers started to shop elsewhere.

Factors affecting Inelastic Price Elasticity of Demand:

1. Infrequent purchases:

It may be a favourite artist’s song or a new phone – consumers are ready to spend extra because it is a one-time buy. Paying a bit more for a one-time purchase has a distinct psychological impact than paying more for a commodity that the consumer purchases on a regular basis.

2. No substitutes:

Consumers have no option except to fill up their automobiles with gasoline. So, even if the price of gasoline doubled, they would still need it to travel. There are just no substitutes, so people are obliged to purchase the item regardless of price. The only other choice is to not drive, which is not an option for many people.

3. Geographical location:

Some goods can establish a “geographical monopoly,” in which consumers have limited options. Consider soccer or baseball games as examples: consumers can only purchase food and beverages offered at the stadium. Because there is no option, the consumer’s willingness to spend is significantly higher, with an element of convenience.

4. Necessities:

Some goods are required for survival, thus buyers must pay whatever the price is. For example, consumers must pay for their prescription regardless of its cost. Without it, kids may get very unwell and require hospitalisation. Other essentials, such as utilities, food, and water, are also required for survival and may be more susceptible to inelastic demand in some instances.

5. Seasonal:

Seasonal items such as mince pies, turkey, and ice cream are common. In the summer, they eat more ice cream, and approaching Christmas, they consume more mince pies. As a result, buyers are prepared to spend more because they gain more utility over the seasons – maybe due to seasonal availability or higher enjoyment experienced at different times of year, such as ice cream during the summer.

Examples of Inelastic Demand:

1. Petrol

2. Salt

3. Monopoly

4. Diamonds

5. Rail tickets

6. Cigarettes

7. Apple iPhone

2) Elastic Demand:

Consumers are particularly price sensitive when a product or service has elastic demand. So, if the neighbourhood Pretzel store raises its prices by 5 cents and loses half of its customers, we may conclude that demand is highly elastic. Consumers are hesitant to spend more and will instead shop elsewhere. In short, price is more important than any other aspect in products/services with elastic demand. Quality is usually overlooked in favour of the lowest price.

We may use insurance as an example, or at least certain forms of insurance such as vehicle and house insurance. There is little difference between products, and comparison websites have grown in popularity as a result.

Factors affecting Elastic Price Elasticity of Demand:

1. Homogeneous product:

Consumers are likely to shop about and respond to price changes if a goods is roughly comparable. An excellent example is insurance. As costs rise, some consumers will hunt for a cheaper provider. Even a few dollars more might cause consumers to go online to compare pricing for a similar policy.

2. Many Substitutes:

When there are several alternative options, a higher price for one makes the others more attractive. There are variety of thousands kinds of chocolates and chocolate bars, for example. Any price difference that is greater than the average may lead to customers picking an alternative.

3. Low Switching Costs:

If there is no cost involved with switching, it increases the likelihood of purchasing a substitute item, enabling demand to vary more. If KitKat prices rise, there is no penalty if you no longer purchase one. As a result, there is no financial penalty for purchasing a substitute. Phone contracts, on the other hand, do the exact opposite, locking consumers in for up to two years.

4. Luxury / Non-necessary:

Luxury goods or services are not required to be purchased, hence consumers may be more price sensitive.

Examples of Elastic Demand

1. Soup

2. Bread

3. Newspaper

4. Chocolate

5. Airline tickets

3) Unitary Demand:

The theory of unitary demand states that as prices rise by X percent, demand falls by the same amount. Let us look at an example. A television maker charges $50,000 for 100 sets. This equates to $500 per unit. It chooses to increase its price by 10% to $550. At the same time, demand declines by 10%, implying that just 90 televisions are sold.

There are no examples of unitary demand in reality. Because human demand is non-linear, this is the case. In other words, there is no direct link between price and demand. Other considerations include the quality and availability of substitute products. So, even if a product becomes 10% cheaper, many people will still select product X since it is their favourite. Coca-Cola, for example, may raise its price by 10%. Demand will not necessarily reduce by 10% because many consumers prefer it over Pepsi and are prepared to pay the extra price.