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. One can also compare a product’s price elasticity with the elasticity of other variables. A product’s price elasticity for instance, according to research findings, 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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