What is Price Elasticity?

Price Elasticity is a measure of the relationship between a change in the quantity demanded of a particular good and a change in its price.

Price Elasticity of Demand (PED) is a term used in economics when discussing price sensitivity. The formula for calculating price elasticity of demand is:

Price Elasticity of Demand = % change in Quantity Demanded / % Change in Price

If a small change in price is accompanied by a large change in quantity demanded, the product is said to be elastic (or responsive to price changes).

On the other hand, a product is deemed inelastic if a large change in price is accompanied by a small amount of change in quantity demanded.

 

Why Is It So Important?

Gathering data on how consumers respond to changes in price can help reduce your risk and that nagging feeling of uncertainty. It will help with forecasting your sales and setting prices. For instance, you can forecast the impact of a change in price on sales volume and sales revenue.

For example, if PED for a product is (-) 2, a 10% reduction in price (say, from £10 to £9) will lead to a 20% increase in sales (say from 1000 to 1200). In this case, your revenue would increase from £10,000 to £10,800.

Having a knowledge of PED helps you decide whether to raise or lower prices, or whether to price discriminate. Price discrimination is a policy of charging consumers different prices for the same product.

If demand is elastic, revenue is gained by reducing the price, but if demand is inelastic, revenue is gained by raising the price. When PED is highly elastic, you can use advertising and other promotional techniques to reduce elasticity.

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