Price Elasticity of Demand: Definition, Formula, Types & Examples

The changes occurring in the demand for a product or service due to a variation in their price is termed as price elasticity of demand. In addition to the change in a product’s price, its quality, availability, and requirement also impact its elasticity of demand. As a business owner, you must understand this concept thoroughly to operate profitably in the market. With an understanding of the demand elasticity formula and the kind of impact you are likely to create by changing the prices of your commodities, you can make informed business decisions.

In this blog, we have detailed the different kinds of price elasticity of demand, the elements impacting it, the significance, and more. Read on to find out.

Price Elasticity of Demand: What is it?

In simple terms, if the demand for a product varies drastically due to changes in its price, then that item is known to be price elastic. Conversely, if variation in price results in just a slight shift in the product’s demand, then it is referred to as price inelastic. 

Price inelasticity and elasticity of demand are further classified into different types including perfectly elastic, unitary, and perfectly inelastic. 

Price Elasticity of Demand: Examples

Here is a look at some examples of price elasticity of demand to understand the concept in a better way:

1. Airline Tickets

It has been observed that any modifications in the price of airline tickets result in a change in their demand. It is thus a perfect example of price elasticity of demand. For instance, if the airfare for travelling from Delhi to Goa increases from INR 4,000 to INR 7,000 per ticket, then the demand for air tickets on this route is likely to fall. When the ticket fare increases, consumers look for other means to travel. They may opt for their vehicle, train, or bus. Alternatively, they may postpone their travel plans. 

On the other hand, if the price of air tickets from Delhi to Goa decreases from INR 4,000 to INR 2,500 per ticket, then their demand is likely to increase. People tend to advance their leisure or even business trips if there is a dip in the airfare. 

2. Decorative Items

Decorative items are not a necessity. Thus, their purchase can be delayed or avoided altogether. Besides, there are several alternatives available when it comes to these items. This makes decorative items price elastic. People usually compare and contrast the rates of these items at different online and offline stores to pick the most lucrative deal. If a shop increases the price of its decorative items by even 20-25% then it is likely to witness a decrease in its sales owing to the various factors stated above.

3. Luxury Goods

Luxury goods are also known to be price elastic because their demand varies with a change in their price. This is because these items such as branded bags, clothing items, watches, and other products are not essentials. There are numerous alternatives to them. Thus, for instance, if a brand increases the price of its bag from INR 10,000 to INR 16,000 then the buyers may look for affordable alternatives or wait for sale or discount offers. Similarly, if the cost of a branded bag or watch goes down by 30-40%, then its demand is likely to surge.

Price Elasticity of Demand: Different Types

Here is a look at the different kinds of price elasticity of demand:

1. Perfectly Elastic – This means that the changes in the price of a commodity result in its demand falling to zero. This occurs when the percentage change in the demand of a product divided by the percentage change in its price equals to infinity.
2. Elastic – The price of a product is said to be elastic when its demand varies significantly with the change in its price.
3. Inelastic – When the change in a product’s price results in an insignificant change in its demand, then it is said to be inelastic.
4. Perfectly Inelastic – When the change in the price of a commodity does not impact its demand at all, then it is said to be inelastic. In such a case, the percentage change in the demand for a product divided by the percentage change in its price is equal to 0.
5. Unitary – When the change in the price of a product has an equal impact on its demand, then it is termed as unitary. For instance, if the cost of a product is increased by 20%, its demand also rises by 20%. In this case, the percentage change in the product’s demand divided by the percentage change in its price equals 1.

Estimating the Elasticity of Demand

Here is a look at the simple demand elasticity formula:

Elasticity of Demand = Percentage change of quantity demanded / percentage change in price

Elements that Impact Price Elasticity of Demand

Here is a look at the factors that have an impact on the price elasticity of demand:

• Urgency of Product

The elasticity of demand also depends on how urgently one requires a product. For instance, you may be planning to replace your old laptop with a new one because it may not be working fine. Now, if the brand you want to purchase it from increases the laptop price, you may still go for it because you have an urgent requirement. On the other hand, if you were planning to purchase it just for an upgrade then you may wait for festive sales or other discount offers. 

• Alternatives Available in the Market

If alternatives of a product/ service are easily available in the market then its price elasticity of demand is likely to be more. For instance, if blue denim is available from several brands at almost the same price and quality, then the brand that increases its price is likely to witness a decrease in its demand.  

• Price Change Duration

If a brand offers a product at a lucrative price for a limited period, then it is likely to witness a sudden surge in its demand. However, if the offer lasts for a season or if the rates are slashed for an indefinite period, then the demand may not surge as drastically.

Understanding the Significance of Price Elasticity of Demand

Price elasticity of demand helps in pricing the products accurately so that their demand increases and so does the business’s profitability. If you understand the concept, you shall be able to identify whether the products you sell are elastic or inelastic. You can devise a better pricing strategy based on this information and thus earn greater profit.

Characteristics of Elastic Products

The features of elastic products are as follows:

• They are not a necessity. Some examples may be luxury watches, branded handbags, decorative items, and fancy clothing items.
• They are not needed urgently. For instance, air tickets for a leisure trip.
• There are several alternatives available for them in the market. For instance, electronic goods, furniture, garments, and kitchenware to name a few.

Traits of Inelastic Products

Here is a quick look at the key characteristics of inelastic goods:

• Their demand does not change significantly even when their price changes. Examples of inelastic products include petrol, diesel, tobacco, and prescription drugs.
• In certain cases, their demand does not change at all. Such products are categorised as perfectly inelastic.
• Substitutes for such products are not easily available in the market.

Conclusion

Price elasticity of demand shows how the demand for a product in the market varies with changes in its price. The outcome varies depending on the kind of items. Luxury goods, furniture, home decor items, and other such products witness a drastic change in demand when their prices fluctuate. On the other hand, there occurs only an insignificant change in the demand for essential items such as milk, bread, fuel, and medicines. By understanding how variations in your products’ prices impact their demand you can make optimal sales and increase your revenue.