Price elasticity of demand

Raise the price and you sell less, but how much less makes all the difference. Price elasticity measures it.

Price elasticity of demand measures how much the quantity demanded of a good responds to a change in its price. Demand is elastic when buyers cut back sharply as price rises, and inelastic when they barely change their purchases. It is the difference between a price rise that boosts revenue and one that destroys it.

Why it governs pricing

The practical power of elasticity is in pricing. If demand is inelastic, raising the price increases revenue, because the percentage rise in price outweighs the small percentage fall in sales. If demand is elastic, raising the price reduces revenue, because buyers flee faster than the price climbs. A firm that does not know its elasticity is pricing in the dark, as likely to lose money by raising prices as by cutting them.

What makes demand elastic

Demand tends to be elastic when close substitutes exist, when the good is a large share of the buyer's budget, and when buyers have time to adjust. It tends to be inelastic for necessities, for goods with no substitute, and for things that cost little relative to income. Salt is inelastic; one particular brand of biscuit, with many rivals on the shelf, is elastic. The same product can be inelastic in the short run and elastic in the long, as buyers eventually find alternatives.

The trap of assuming

Firms and governments alike come unstuck by assuming a good is more inelastic than it is. A tax or price rise that looks like easy revenue can collapse demand if buyers have more alternatives than expected, while a discount meant to drive volume can simply give away margin if demand was inelastic all along.

Price elasticity is a reminder that the reaction to a price change matters as much as the change itself. The number is often hard to know precisely, but the habit of asking how sensitive buyers really are, rather than assuming, separates pricing from guesswork.