Price Elasticity of Demand Guide: Formula, Strategy & Examples

When retailers develop a pricing strategy, they take into account a multitude of factors, one of which is price elasticity of demand. This is an important metric that can help you find out whether customers’ buying ability will change after price corrections and to what extent it may be impacted.

In this guide, you will find out exactly how knowledge of price elasticity can be useful for your marketing strategy, plus learn the formula to calculate it and the factors that impact it. We will review examples of elastic and inelastic products for you to define the category of your items, as well as the ways of price elasticity management.

Price elasticity of demand shows the correlation between price changes and customers’ demand (the quantity they are ready to buy). Practice shows that higher prices make consumers buy less, and lower prices motivate them to buy more. The demanded quantity cannot stay unchanged after price corrections, especially considerable ones.

Market research shows 46% of people are ready to pay more for the brands they trust. That means there are both pricing and non-pricing factors that motivate consumers to spend more money on products, even with a large number of cheaper alternatives around. Price elasticity of demand is made up of all these factors. A correctly calculated price elasticity allows retailers to boost their profit while maintaining customer loyalty.

Price elasticity is a foundational term in economics that measures how the quantity demanded of a good or service responds to a change in price. It plays a critical role in understanding consumer behavior, shaping pricing strategies, and analyzing market trends.

Understanding Elasticity Through Real-Life Examples
In everyday life, price elasticity explains why certain goods experience drastic changes in demand when prices fluctuate, while others remain largely unaffected.

• Elastic Products

These are goods or services where even a small price change significantly alters the quantity demanded. For instance, if the price of branded coffee increases by 20%, many consumers may switch to cheaper alternatives, reflecting an elastic demand curve. Luxury items like high-end electronics or vacations often fall into this category, as they are non-essential and have substitutes.

• Inelastic Products

These are necessities or goods with limited substitutes, such as essential medicines or fuel. A 10% increase in the price of gasoline may only lead to a 2% reduction in quantity demanded, as consumers have few alternatives. This behavior aligns with the concept of relatively inelastic demand, where the percentage change in demand is smaller than the percentage change in price.

The Importance of Price Elasticity in Economics
Understanding price elasticity helps businesses, policymakers, and consumers make informed decisions:

• Businesses use elasticity to set prices that optimize total revenue. For example, raising prices on inelastic goods can increase profitability without significantly reducing sales.
• Governments consider elasticity when imposing taxes. High taxes on inelastic goods like cigarettes can generate substantial revenue without drastically reducing consumption.
• Consumers make decisions based on elasticity when choosing between products or adjusting their budgets for price increases.

Let’s observe it by means of an example. Your brand sells ice cream for $6: at this price level, the demand keeps around 80 items per day. Once you lowered the price to $4, your sales volume increased to 100 items per day. To calculate the price elasticity of demand, use the following formula:

Price elasticity of demand = % change in quantity / % change in price

First, you need to calculate the percentage of the changes. Let us observe equations with examples:

Where:

Q1 - The initial sales volume (quantity) - 80 items
Q2 - Sales volume after price change (quantity) - 100 items
P1 - The initial price - $6
P2 - The new price - $4

Now, we can calculate the price elasticity of demand:

22.2 / -40 = -0.55

We get a negative number between 0 and -1. That means you do not have enough price elasticity to decrease or increase prices. If the price changes by 1%, the demand will alter by only 0.55%, and a 10% change in price will shift the demand by 5.5%.

Note that in most cases, price elasticity is negative (it is below zero). However, for the purpose of convenience, only positive numbers are used to denote the elasticity. While elasticity keeps below 1 (or above -1), the product is considered to be inelastic.

A positive price elasticity (higher than 1) means that a product is elastic, i.e., a higher price will result in a growth in demand. This is a rare situation that usually happens in particular markets, such as luxury goods.

Depending on the market and choice of analog products, we can talk about elasticity or inelasticity of demand. For example, the Apple brand is so popular and trustworthy that consumers are ready to pay extra for their iPhones and MacBooks. If the price of an iPhone rises, the majority will still want to buy a smartphone. For less known brands like Lenovo, you would expect the demand to be elastic — customers will not buy their electronic devices if they are priced on par with Apple.

However, when it comes to the retail sphere with its huge variety of analog offers, price elasticity of demand is evident. For example, one store sells wooden chairs for $40, and the second store offers analog chairs for $50. If the entire market starts buying at $40, it would mean that the demand totally depends on the price, and the product’s quality or material are of no importance. This is a perfectly elastic product, i.e., the demand is defined by a price only.

Price elasticity of demand is a critical concept in economics, helping businesses and policymakers understand how a change in price impacts the quantity demanded. Let’s walk through a practical example of how to calculate elasticity when the price of a product increases from $80 to $100.

Scenario:

• Initial price (P1): $80
• Final price (P2): $100
• Initial quantity demanded (Q1): 1,000 units
• Final quantity demanded (Q2): 900 units

Step 1: Calculate the Percentage Change in Price
Using the midpoint formula:

Step 3: Calculate the Price Elasticity of Demand
The price elasticity of demand formula is:

Step 4: Interpret the Results

• The calculated price elasticity of demand is -0.47.
• This indicates that the product is relatively inelastic, meaning that the quantity demanded is not highly responsive to price changes. For every 1% increase in price, the quantity demanded decreases by less than 0.5%.

Why Does This Matter?
Understanding the price elasticity helps businesses decide whether to increase the price of the product. In this example, because demand is inelastic, a price increase from $80 to $100 may lead to higher total revenue. This is because the loss in sales volume is proportionally smaller than the price increase.

By leveraging tools like Priceva’s price elasticity measures, businesses can estimate demand responses to price changes, allowing them to optimize pricing strategies effectively. This data-driven approach ensures decisions are based on actual demand behavior rather than guesswork.

Price elasticity of demand can be defined by a large multitude of factors. Although brand perception and attractiveness of promotional campaigns play an important role, there are many other aspects motivating customers to make a purchase or search for alternatives.

Here is what should be taken into account when forecasting and defining price elasticity of demand:

• If the price of a product is equal to or higher than the price offered by a market leader for the analog, the elasticity is high. In this case, relative price availability matters most, and it evolves around the market leader (customers are likely to compare the leader’s prices with other offers).
• To maintain optimal demand, retailers should assess customers’ brand awareness and analyze their competitive strengths. If your brand is not very popular, you will build your strategy on price adjustments, so you should always calculate the cost of items in regard to the market leader.
• Price elasticity also depends on the quality of the product, or to be more precise, its market value. When items have more or less the same properties and quality — for example, dishwashing sponges have barely any differences — brands cannot sharpen their competitive edge by emphasizing the advantages of their commodity. In this case, consumers will buy a cheaper or better-advertised product.
• Significant price increases can repel customers, so retailers practice a single-digit price increase and do not raise the price of a product by more than 9.9%. Otherwise, customers may get dissatisfied and will buy less.
• The highest price elasticity is observed in mass-market products where the selection is huge, and products have pretty much the same quality. On the other hand, minimum price elasticity is typical for luxury items and the economy.
• Price elasticity of demand can be different for various categories of buyers. Loyal customers will keep buying the product even after price changes, which contributes to higher price elasticity.

As mentioned above, different segments of products demonstrate different levels of elasticity. Let’s take a closer look at these categories.

In case of a minor price change, the demand for these products will shift significantly. These products are also called “pure commodities.”

Elasticity is typical for products that are discretionary and have many substitutes. For example, cereal is a type of food that is optional in anyone’s diet. If a cereal brand raises the price, buyers may stop purchasing the product entirely: they will find cheaper alternatives.

Thus, perfect elasticity is typical of markets where products have similar quality, so price becomes the major differentiation point.

In this case, relatively small changes in price cause serious changes in the product demand. This is a common situation for luxury goods like TVs and designer brands. They cost a lot, and a small shift in availability can make a significant difference. At the same time, it depends on the customer segment. Buyers with an average salary make their choice depending on the price, while some premium retailers (for instance, the most acknowledged fashion houses) serve only deep-pocketed clients, which means demand will barely change.

For such products, any change in price leads to an equal shift in demanded quantity. In this case, the price elasticity equals 1. A good example of unit elastic products is fruits. For instance, John sells mangoes for $3 per pound. If the price of mangoes rises by 10%, John’s sales will decrease by 10% because people will start buying bananas, apples and other sorts of fruits.

Unit elasticity is observed when the demand depends mostly on the price because there are many substitutes on the market (even if they are not identical), and those products are not of primary importance.

For such products, a significant change in price is not likely to affect the quantity of items sold. Basic foods are a good example: if the price of eggs changes by 5%, people will still continue buying them. The demand will barely change because there are practically no substitutes, and the quality of eggs of different brands is pretty much the same.

For this group of goods, any change in price does not impact demand. In reality, perfectly inelastic products are theoretical concepts because consumption level can change even for life-essential goods, such as water or gas. For example, when tap water is potable and cheap, it is consumed in large amounts, but when it is expensive, it will be used more judiciously. People need gas to drive cars and have access to transportation, so they are forced to purchase it at any price before alternatives appear in the long run.

Understanding the difference between elastic and inelastic demand is essential for businesses aiming to optimize pricing strategies and predict customer behavior. These two types of demand determine how consumers respond to price changes, influencing revenue and market dynamics.

Elastic demand refers to products or services where the quantity demanded is highly sensitive to price changes. Even a small price increase can lead to a significant drop in demand, as consumers are quick to seek alternatives or forego the purchase altogether. Luxury goods, branded electronics, and discretionary items like vacations are prime examples. These products often have substitutes or are non-essential, making them highly susceptible to consumer price sensitivity. Economically, elastic demand is characterized by a price elasticity of demand greater than 1, meaning the percentage change in quantity demanded exceeds the percentage change in price. For businesses, this implies that a price increase could reduce total revenue, while lowering prices could drive higher sales and revenue.

In contrast, inelastic demand applies to goods and services where consumers show little responsiveness to price changes. Essential items like medications, basic food staples such as bread and rice, and utilities like water and electricity fall into this category. These products are necessities, and their consumption remains relatively stable regardless of price fluctuations. Inelastic demand is represented by a price elasticity of demand less than 1, where the percentage change in price exceeds the percentage change in quantity demanded. This behavior allows businesses to increase prices without significantly affecting sales volume, often leading to higher total revenue.

The core difference lies in price sensitivity. Elastic demand demonstrates high sensitivity, where small price changes cause noticeable shifts in buying behavior. In contrast, inelastic demand shows low sensitivity, as consumers prioritize availability over cost. For example, raising the price of a luxury car may drastically reduce its sales, while a similar increase in the price of essential medicine may not significantly impact demand.

Elasticity curves and graphs are essential tools for visualizing how changes in price affect the quantity demanded of a product or service. These curves provide a clear representation of the relationship between price and demand, enabling businesses and economists to analyze and predict consumer behavior effectively.

Demand Curves: Elastic vs. Inelastic
The demand curve is a graphical representation of the relationship between the price of a good and the quantity demanded. For elastic products, the demand curve appears flatter, indicating that a small change in price leads to a significant change in quantity demanded. For example, a 10% price increase on a luxury product like a smartphone might reduce demand by 20%. This high sensitivity is characteristic of goods with readily available substitutes or non-essential nature.

In contrast, inelastic demand curves are steeper, showing that even a large price change results in only a minor change in demand. Products like essential medicines or electricity demonstrate this behavior. A 20% increase in price may only reduce demand by 5%, as consumers prioritize necessity over cost. The curve’s slope reflects this reduced sensitivity.

Perfectly Elastic and Perfectly Inelastic Curves
Extreme cases of elasticity are represented by perfectly elastic demand and perfectly inelastic demand. A perfectly elastic curve is a horizontal line, indicating that consumers will only buy the product at one specific price. Any increase results in zero demand. Conversely, a perfectly inelastic curve is a vertical line, showing that quantity demanded remains constant regardless of price changes, such as life-saving drugs.

Understanding Through Graphs
By plotting data on graphs, businesses can calculate the price elasticity of demand at various points along the curve. This involves using the formula for elasticity, which compares the percentage change in quantity demanded to the percentage change in price. The resulting value determines whether the demand is elastic (>1), inelastic (<1), or unitary (=1).

By using the above-mentioned formula, you can calculate an exact price elasticity of demand. But what if you do not have sales volume statistics at your fingertips? There are several criteria that will help you define how elastic the product is.

Necessities like water or gas are usually inelastic because people cannot stop buying them, so they have to accept whatever price the seller sets. Luxury items, on the contrary, are very elastic because they are easy to go without. Those include entertainment, delicious foods, expensive brand clothing, etc. Thus, you should understand how indispensable your products are.

If your product has many analogs on the market and the competition is fierce, rising prices are most likely to repel customers. This is relevant for such categories of products as clothes, foods, homeware, and so on.

In the software and SaaS sphere, product differentiation is also important and easier to achieve. You can introduce essential functions plus some features that customers cannot find in competitors’ solutions - that will make your product irreplaceable. Besides that, users are less likely to switch to another solution when the procedure is too complicated, inconvenient or time-consuming (for example, in the website hosting sphere).

For cheaper items, price changes are hardly noticed by customers. No one minds paying 5-10% extra for a pencil, but when you want to buy a car, a 10% discount is a considerable difference that will influence your decision.

Price changes have an impact on demand in the long run — people learn to manage without certain items, or find alternatives within weeks or months. Hence, changing prices for a few days won’t make a difference in demand. If gas prices rise for a week or two, people will complain but will still continue filling their vehicles with fuel.

However, when gas becomes too expensive in the long run, they may decide to switch to smaller cars or electric hybrids. So, even if your product is inelastic, think of the lasting impact of price changes.

Understanding and managing price elasticity is crucial for developing strategies that enhance profitability and market positioning. Price elasticity of demand helps businesses determine how much they can adjust their prices without significantly losing customers. By carefully analyzing elasticity, companies can find the sweet spot where total revenue is maximized while meeting market expectations.

For example, if demand is elastic, a small price reduction can lead to a greater increase in quantity demanded, resulting in higher revenue. Conversely, if the demand is inelastic, businesses can increase the price without a substantial drop in sales volume, maximizing profit margins.

Tools like Priceva’s dynamic pricing solution simplify the process of elasticity analysis. By offering real-time insights into market behavior and historical price trends, Priceva enables businesses to calculate optimal price points for different products. For elastic products, Priceva helps identify competitive pricing strategies to attract price-sensitive customers, while for inelastic goods, it provides tools to adjust prices to capitalize on higher margins. This data-driven approach reduces guesswork and ensures pricing decisions align with demand curves.

Several industries demonstrate how elasticity management strategies can be effectively implemented:

1. Dynamic Pricing Models in Airlines Airlines use real-time data to adjust ticket prices based on demand, supply, and time. By leveraging price elasticity, they maximize ticket sales during off-peak periods and retain high prices during peak seasons.
2. Tiered Pricing Plans in Subscription Services Subscription platforms like streaming services utilize tiered pricing to appeal to customers with varying willingness to pay. Elasticity insights ensure that lower tiers attract budget-conscious users, while premium tiers cater to those seeking added value.
3. Retail Discount Campaigns During Seasonal Sales Retailers frequently run seasonal sales campaigns, offering discounts on elastic goods like clothing or electronics. By strategically lowering prices, they boost volume and clear inventory while increasing total revenue.
4. High-Price Retention for Inelastic Luxury Goods Brands selling inelastic products like luxury watches or high-end vehicles maintain premium pricing to reinforce exclusivity. Periodic promotions or limited-time offers are used sparingly to stimulate demand without undermining the product’s perceived value.

With Priceva’s powerful price monitoring and optimization tools, businesses can replicate these successful strategies. Priceva provides insights into competitive dynamics, demand elasticity, and customer behavior, empowering brands to implement pricing models that align with market conditions while maximizing profitability.

The price elasticity of demand should not be overlooked, because it will let you know how price changes impact the quantity of items sold. Use the simple calculation formula to discover the elasticity of your products, and remember that even for essential inelastic commodities, price shifts can cause demand change in the long term. Knowing about the importance of your products and customers’ behavior will also help you evaluate elasticity.

Perfect elasticity is when demand shifts dramatically after a price change. Relative elasticity is when price corrections cause tangible changes in demand. Unit elasticity (equals 1) is when the percent of price change is equal to the percent of demand change. Relative inelasticity is when demand barely alters after a price correction. Perfect inelasticity is when demand does not depend on the price at all.

Luxury items and some foods are not life-essential, so price corrections influence consumption of a product. Also, any goods with a large number of alternatives have a price-sensitive demand.

Any commodities essential for life, such as electricity and water. People cannot stop buying them because those products help us live and meet our basic requirements (food, shelter, safety).

This metric shows whether and how price fluctuations can impact demand for a product. With so many competitive markets around, it is important to plan your pricing strategy ahead of time in order not to experiment with customers. Price elasticity can be used to develop optimal pricing strategies and allows you to stay among the strongest competitors.

The formula for price elasticity of demand is:

Price elasticity of demand = % change in quantity / % change in price

This equation helps measure how responsive quantity demanded is to a price change. For example, if the price of a product increases by 10% and quantity demanded decreases by 20%, the price elasticity would be -2.

To estimate price elasticity of demand, gather data on quantity demanded and corresponding price changes over a specific period. Calculate the percentage change in quantity demanded and the percentage change in price, then apply the elasticity formula. This approach helps determine whether demand for a product is elastic or inelastic.

Price elasticity is measured by dividing the percentage change in quantity demanded by the percentage change in price. For accurate results, use mid-point calculations or average prices to minimize discrepancies. Graphing the demand curve also provides a visual representation of elasticity at different price points.

To calculate elasticity between these price points, use the midpoint formula:

Elasticity = Change in Quantity Demanded (Q2 - Q1) / Average Quantity Demanded (Q1 + Q2)/2 ÷ Change in Price (P2 - P1) / Average Price (P1 + P2)/2

This calculation gives a clear value showing whether demand is elastic or inelastic between $80 and $100.

A price elasticity of 0.5 indicates inelastic demand. This means that the percentage change in quantity demanded is smaller than the percentage change in price. For example, raising the price of the good by 10% would result in a less than 5% drop in quantity demanded.

Yes, inelastic demand occurs when the price elasticity of demand is less than 1. This signifies that consumers are less responsive to price changes, which often applies to essential goods like food or medicine.

Price elasticity of demand measures how much the quantity demanded of a product changes in response to a change in price. For example, if a good has high elasticity, even a small price change can cause a significant shift in demand. Conversely, low elasticity means demand is less affected by pricing.

A price elasticity of 1.5 indicates elastic demand, meaning that the percentage change in quantity demanded is greater than the percentage change in price. For instance, if the price of an elastic product increases by 10%, demand may decrease by 15%. Elastic products typically include non-essential or luxury items.