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Price elasticity

The principles of demand tell us that when the price goes up, the quantity demanded goes down and vice versa. But when prices change, how much do the quantities demanded change? By a lot or just by a little? This is what elasticity measures.

Demand is said to be elastic if the quantity demanded changes a lot when the price changes slightly.

Conversely, demand is said to be inelastic if the quantity demanded changes very little when the price changes slightly.

The price elasticity of demand measures the sensitivity of demand to a change in price.

Price elasticities are generally negative.

A cartoon illustration of price elasticity An illustration of price elasticity (Click to expand)

Variability of the price elasticities

Some goods have more elastic demand than others. Typically, demand for essential goods like petrol, electricity or even mobile phones is less elastic than demand for non-essential goods like sweets, spinach or haircuts!

Of course, it depends on what people consider essential to their well-being – remember, people are all different. Whatever the global elasticity on the market for coffee beans, some people are hooked on caffeine or consider it part of their everyday life, so for them it is an essential good. They won’t reduce their consumption if the price goes up, while others may not consider it essential, and will drink something else like tea.

Price elasticity examples Price elasticity examples (Click to expand)

Measuring the price elasticity

The price elasticity is measured by a number. For example, if the price elasticity of tomatoes is –4, it means that as the price goes up by 1 percent, demand will go down by 4 percent. This is a case of an elastic demand.

If the price elasticity is small (less than 1 in absolute terms), an increase of 1 percent in the price will have a smaller impact on demand (less than 1 percent). The quantity sold of a good will only go down slightly. Demand will be qualified as inelastic to a change in price.

A tool for price management

In real life, producers are very concerned about the price elasticity of demand of their clients. Some groups of clients might be more price sensitive than others, and offering them a low-priced product might be a good thing to increase the volume sold and the revenue.

Conversely, it may be a good idea to get to know the customers who are not price sensitive, in order to see if it is possible to offer them a ‘better’ product, closer to what they really like (cappuccino instead of plain coffee, for example), and sell it to them at a higher price.

This is what price elasticity will be used for by smart producers in order to manage their prices.

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An Introduction to Pricing Strategy and Revenue Management

École Nationale de l'Aviation Civile

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