Definition: The elasticity of demand is an economic principle that measures the extent of consumer response to changes in quantity demanded as a result of a price change, as long as all other factors are equal. In other words, it shows how many products customers are willing to purchase as the prices of these products increases or decreases.
What Does Elasticity of Demand Mean?
The elasticity of demand formula is calculated by dividing the percentage that quantity changes by the percentage price changes in a given period. It looks like this:
Elasticity = % change in quantity / % change in price
Therefore, the elasticity of demand is the percentage change in the quantity demanded as a result of a percentage change in the price of a product. Because the demand for certain products is more responsive to price changes, demand can be elastic or inelastic. When the demand for a product is elastic, the quality demanded is highly responsive to price changes. When the demand for a product is inelastic, the quality demanded responds poorly to price changes. Thus, a change in price will affect an elastic product’s demand, but it will have little effect on an inelastic product’s demand.
Let’s look at an example.
Generally speaking, the price elasticity of demand for a product depends heavily on how many substitute goods there are for this particular product.
For example, Mary has red and black pencils. If the price of red pencils drops because consumers are not interested in the color of the pencil but in utility, demand will increase for the black pencils for one reason: black and red pencils are perfect substitutes, so either can meet consumer needs. However, if the price of red pencils drops and the quantity demanded decreases as well, the demand for red pencils is elastic since the quality demanded is highly responsive to price changes due to the existence of black pencils (perfect substitutes).
Jack smokes two packages of cigarettes daily and he pays $6 per pack. If the price of cigarettes increases to $8 per package, Jack will have to pay $16 daily to satisfy his need. However, because there are very few substitutes for tobacco, Jack will continue to buy his package of cigarettes in spite of the price change. In this case, demand for tobacco is inelastic because the price change doesn’t really affect the quality demanded.