Price Elasticity: What It Is & How to Calculate It

Price elasticity is one of the most cardinal, all-important economic concepts any business owner or sales professional needs to understand. Having a pulsate on the price elasticity of your offerings is cardinal to forecasting efficaciously, structuring a sound price strategy, and building a responsive, successful company .person writing on a notepad to calculate price elasticity
But what is price elasticity ? How do you calculate it ? What are the unlike types of price elasticity ? And what do they mean for your commercial enterprise ? here, we ‘ll answer all of those questions and more. Let ‘s dive in .
What is price elasticity ?

How to Calculate Price Elasticity
Price Elasticity of Demand
Price Elasticity of Demand Formula
Types of Price Elasticity of Demand
Price Elasticity of Supply
Price Elasticity of Supply Formula
Cross Price Elasticity
Cross Price Elasticity Formula

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What is price elasticity?

Before we break things down, let ’ s get down by tied setting on price elasticity in general. Price elasticity measures how sensitive the necessitate and provide of your product are to changes in price. For example, the price elasticity of demand measures many customers will continue to purchase your product or service if you increase the monetary value .
Price elasticity can fall into one of three buckets :

  • Price elastic — where price changes greatly affect the supply or demand of a product or service.
  • Price inelastic — where supply and demand will work inversely (a.k.a. in the opposite direction) to price changes.
  • Price unit elastic — where a price change is proportional to the change in supply and demand and they move at the same rate.

now that we have a feel for what price elasticity is, let ‘s take a expression at how to calculate it .

How to Calculate Price Elasticity

To calculate price elasticity, divide the change in necessitate ( or supply ) for a product, serve, resource, or commodity by its change in price. That name will tell you which bucket your product falls into .

  • A value of one means that your product is unit elastic and changes in your price reflect an equal change in supply or demand.
  • A value of >1 means that your product is elastic and changes in your price will cause a greater than proportional change in supply or demand.
  • A value of <1 means that your product is inelastic and changes in your price will result in a smaller change in the supply or demand for your product.

To illustrate these economics, here ’ s a chart that shows all three buckets :
a chart mapping the relationship between the three pricing elasticity buckets
Image source

How can you apply price elasticity?

Price elasticity gives you some useful information on how to best monetary value your products and services .
If you have an elastic intersection, then you should be cautious about raising prices since a price addition will greatly impact purchases ( demand ) and production ( supply ). But if your offer is monetary value inelastic, then you can adjust your prices with less caution since you know that the change will have a smaller impact on add and requirement .

now that we ’ ve cover how price elasticity impacts your business, let ’ s break things down even further .

Price Elasticity of Demand

The formula below ( besides known as PED ) is used to identify how a change in price affects the supply or need of an offering or commodity. If people still buy a intersection, service, or resource when the price is raised, that offer is inelastic. An put up is elastic when demand suffers due to monetary value fluctuations .
For exercise, research shows that raising cigarette prices doesn ’ thymine do much to stop smokers from buying cigarettes — making cigarettes an inelastic commodity. cable television television, however, is a identical elastic product. As the price of cable has increased, demand has decreased as more consumers “ cut the cord. ”

Substitutions like Netflix, Hulu, and other streaming services have made the cable industry elastic. There are besides substitutions for Tobacco ( including alternatives like vaporizers and nicotine patches ), but none have affected their core consumer ’ sulfur desire and ability to continue buying cigarettes .

Price Elasticity of Demand Formula

% Change in Quantity / % Change in Price = Price Elasticity of Demand
If you sell 10,000 reams of newspaper at $ 100 per ream and then raise the price to $ 150 per ream and sell 7,000 reams, your elasticity of need would be -0.88. This would be considered inelastic because it is less than one .
Broken down even further to include the calculation of percentage change, this recipe looks like :
( ( QN – qi ) / ( QN + QI ) / 2 ) / ( ( PN – principal investigator ) / ( PN + PI ) / 2 )

  • QN = New quantity (7,000)
  • QI = Initial quantity (10,000)
  • PN = New price ($150)
  • PI = Initial price ($100)

Our numbers plugged into this formula would be :
( 7,000 – 10,000 ) / ( 7,000 +10,000 ) /2 ) / ( 150 – 100 ) / ( 150 – 100 ) / 2 )
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This formula is helpful in determining if a merchandise or military service is price medium. ideally, you want your offer to be a must-have ( inelastic ) that consumers consider non-negotiable during price variation, not a nice-to-have ( elastic ) .

Types of Price Elasticity of Demand

1. Perfectly Inelastic Demand

If your PED equals 0, price changes do not affect your merchandise ’ second requirement. Generally speak, only absolutely necessity items and services have perfectly inelastic requirement. Very few — if any — products or services like that exist, making absolutely inelastic necessitate a by and large hypothetical concept.

For example, if there were a life-saving drug on the commercialize that people would pay any price to obtain, demand would remain the same no matter how much the price might rise .
a graph of perfectly inelastic demand Image informant

2. Relatively Inelastic Demand

If the percentage variety for demand is less than the percentage switch of the intersection ’ sulfur price. necessity goods and services that people would be will to pay more for have relatively elastic demand — in most cases .
This frequently includes goods or resources with no close substitutes like electricity — a near-essential resource without any feasible alternative. Losing access to it would have massive implications on your daily animation, and you ‘d have nowhere else to turn when that happened .
For the most part, people would be volition to cover any price increases to keep their power on. That said, electricity is n’t angstrom critical as a life-saving drug, so some people would be will to go without it if the monetary value were besides steep — making demand for it relatively inelastic .

3. Unit Elastic Demand

If the change in demand for a product or service yields a proportional variety in monetary value — meaning a price raise of X % leads to an ten % decrease in demand — the offer in interrogate has unit rubber band demand .
This type of monetary value elasticity of demand is strictly conjectural. There are no actual examples of whole elastic demand in drill. requirement is never wholly linear. Though there is obviously a direct relationship between price and demand, that relationship is never squarely one-to-one .
If a stigmatize were to slightly raise its prices, it would inactive likely have consumers who prefer it to its alternatives enough to continue to buy its products or services — so a 10 % raise in price would n’t mean precisely 10 % of existing customers mechanically turn to that company ‘s competitors .
In a similar vein, an highly radical price hike for a incidental product or service might turn off a disproportionately gamey total of customers, relative to the percentage change in prices. If a brand decided to raise prices 40 % without warning — more than 40 % of its existing customers might jump ship .

4. Relatively Elastic Demand

If need variety is greater than the change in your product ’ s price. here, a relatively belittled switch in price will make for a very boastfully change in necessitate. relatively elastic demand is typically associated with items that have respective substitutes .
For case, let ‘s say there ‘s an electronics manufacturer that sells 40-inch bright TVs for $ 250. All of its competitors sell similar products for the like price — and those competitors ‘ TVs have virtually indistinguishable settlement and features from the manufacturer in question .
If the manufacturer were to raise its price from $ 250 to $ 275, consumers would probably be less incline to pay an extra $ 25 for a product that ‘s then basically similar to its slenderly less expensive competition — and requirement for the manufacturer ‘s television would drop fairly radically, making its demand relatively rubber band .

5. Perfectly Elastic Demand

If necessitate falls to zero at the slightest price increase or demand becomes great with a slight price decrease. absolutely elastic necessitate demonstrates that the demand for a product is 100 % directly tied to its price .
Like unit of measurement elastic need, there are no actual examples of absolutely elastic requirement in practice. need for a product or military service is never linear enough to make any change in price prompt an absolute drop in necessitate .
There will always be some people who have preferences that are often undaunted by flimsy price changes. If the price of a bottle of Sprite was to increase by $ 1, there will still be consumers bequeath to pay more for it over alternatives like Sierra Mist or 7Up .
While some offerings have particularly price-sensitive customer bases, there are n’t any that consumers will wholly abandon arsenic soon as that good costs tied one penny more than it did earlier .

a graph of perfectly elastic demand
Image reservoir

Price Elasticity of Supply

The price elasticity of provide ( PES ) measures how responsive the supply of a merchandise or service is when there is a change in price .
If issue is inelastic, it might mean a company is excessively short-handed to keep up with necessitate, needs a longer lead time to produce more of its product, or does n’t have the resources to expand its facilities .

If supply is elastic, a company might have a excess of available staff to increase provide. Knowing PES allows businesses to determine whether a change in monetary value will negatively or positively affect the demand for its product or service .

Price Elasticity of Supply Formula

Price Elasticity of Supply = % change of add / % variety in price
If add is inelastic, an increase in price leads to a change in provide that ‘s less than the increase in price, meaning the PES is less than one. If add is rubber band, the price change yields a larger increase in supply making the PES greater than one .

For example, if the price of “ World ’ s Greatest Boss ” mugs falls 10 % and the supply falls 5 %, the PES is .5 and considered inelastic. If the price of bobbleheads increases by 15 % and add increases by 20 %, the price elasticity of provision ( PES ) is 1.3 and elastic .
Cross Price Elasticity
Cross price elasticity of demand measures how responsive the demand for a merchandise or service is when the price for another intersection or military service changes. For example, if Hulu with Live television raises its prices to $ 45 per month, will customers leave the serve for YouTube TV — a exchangeable streaming service charging alone $ 40 per calendar month ?
As the price of Hulu Live rises, the demand for its rival ’ sulfur avail rises. Within hybrid monetary value elasticity, YouTube would be considered a “ alternate good. ”
If, however, the cost of televisions increased and the number of customers using subscription services like Hulu or YouTube decreased because of the price increase of televisions, this would be called “ complementary goods. ”

Cross monetary value elasticity allows businesses to price their products or services competitively, plan for risks, and map their grocery store. If your product or overhaul has no real rival, you do n’t need to consider crabbed price elasticity because there is no substitute for your offer. however, if a complementary color intersection or service sees a market fluctuation, you might need to prepare for cross price elasticity .

Cross Price Elasticity Formula

Cross Price Elasticity of Demand = % change in quantity demanded for Product A / % change Product B ’ sulfur price
Your product or service ‘s price elasticity can inform your price strategy, help you feel out your competitive advantage, and ultimately dictate how your company plans for the future. Given the massive implications it can have on your business, having a handle on price elasticity — as a concept — is in your best matter to.

Editor ‘s eminence : This position was in the first place published in April 3, 2019 and has been updated for comprehensiveness .
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