Price Elasticity of Demand

Elasticity refers to the degree of responsiveness of one variable to another. Price elasticity of demand is a measure of the responsiveness of demand (sales quantity) to a change in price, and it is determined by the following equation:

$$ \varepsilon = Price \,Elasticity $$ $$ Q = Sales \,Quantity $$ $$ \varepsilon = \frac{\%\,Change\,in\,Sales}{\%\,Change\,in\,Price} = \frac{dQ/Q}{dP/P} = \frac{P}{Q}\frac{dQ}{dp}$$

The notion of elasticity of demand, applies similarly for other elements of the marketing mix. Advertising elasticity for instance is the percentage change in sales volume due to a percentage change in advertising.

The definition of elasticity is units-free. A pure measure of responsiveness, its value can be compared across products, markets, and time, making it a useful tool for decision-making. Additionally, it is possible to compare a product’s price elasticity with the elasticity of other variables. For instance, it is often compared with advertising elasticity, and research findings have shown that a product’s price elasticity tends to be 15 to 20 times higher than its advertising elasticity.

Since sales quantity typically decreases with increase in price, price elasticity is usually a negative number. However, it is normally reported as an absolute value.

Price elasticity of demand may be interpreted as follow:

  • ε > 1: Demand is elastic. If price is increased, revenue (price × sales volume) will decrease. The increase in price is offset by a proportionately larger reduction in sales volume.
  • ε < 1: Inelastic. If price is increased, revenue will increase.
  • ε = 1: Unit elastic. There is no change in revenue with change in price. The proportionate change in sales volume is same as the proportionate change in price.
  • ε = 0: Perfectly inelastic demand. Sales volume is constant.
  • ε = ∞: Perfectly elastic demand.

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