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.
