Price Elasticity of Demand
Price elasticity of demand measures how sensitive the demand for the product is as a result of a change in price.
Price elasticity of demand is calculated using the following formula:
% change in demand
% change in price
If the answer is more than 1 the demand for the commodity is price elastic. That means the percentage change in the volume of demand is greater than the percentage change in price. When businesses sell goods or services that are price elastic, they have to be very careful about changes in price as there is a risk that it will lead to significant changes in the volume of demand.
If the answer is less than 1 the demand for the commodity is price inelastic. In this case, percentage changes in the volume of demand will be less than the percentage change in price. An example of an inelastic product is fuel, e.g., gas. When the price of gas goes up, people are able to choose to use less but generally (in the short term) they will have to pay the new price. So, even when the price of such goods rises significantly, no similar change takes place in the volume of demand.
This means that raising the price of inelastic goods can lead to higher incomes and profits.
Elasticity is affected by:
Availability of Substitutes
If there are multiple substitutions the price is likely to be elastic. As a result, customers will have much more choice. Therefore, if a business increases the price of a product, the customer can buy another product. For example, if the price of a train ticket increases, customers may use another mode of transport such as a bus or car.
Time
Over time, every commodity or product is price elastic. For example, if the price of gas is higher compared to other fuels, over time people will switch to other types of fuel such as installing solar panels or air source heat pumps. As a result of this, the demand for gas will decrease.
Branding
Goods with a strong brand command customer loyalty. This means that people will continue to buy their goods when the price goes up or even when the price of their competitors is lower. Consider the market for soft drinks like cola where you have famous brands such as Pepsi and Coca Cola. Although these drinks are very similar in taste, a significant number of customers would never switch from one brand to another.