Price Elasticity
A measure of how sensitive demand or supply is to a change in price.
What is Price Elasticity?
Price elasticity measures the percentage change in quantity demanded or supplied in response to a 1% change in price. Demand is elastic (elasticity > 1) when consumers are highly price-sensitive — luxury goods and brand-name products with generic alternatives typically fall in this category. Demand is inelastic (elasticity < 1) when consumers continue buying despite price increases — gasoline, insulin, and cigarettes are common examples. Businesses use price elasticity to set optimal prices: for inelastic goods, raising prices increases revenue; for elastic goods, it reduces revenue. Governments use elasticity estimates to predict the behavioral and fiscal effects of taxes and subsidies.
Example
A pharmaceutical company raises the price of a branded drug from $100 to $120 (a 20% increase). Demand falls from 10,000 units to 9,500 units (a 5% decrease). Price elasticity of demand = −5% ÷ 20% = −0.25. Because the absolute value is less than 1, demand is inelastic — the 20% price increase only reduced demand by 5%, and total revenue rose from $1,000,000 to $1,140,000.