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Price and Income Elasticity of Demand

Last updated Dec 7, 2022 Edit

Elasticity measures the responsiveness of demand to a change in a relevant variable—such as price or income.

Price elasticity of demand—measures the extent to which the quantity of a product demanded is affected by a change in price.

Price Elasticity of demand (PED) is calculated using:

% change in quantity demanded / % change in price

Price elastic=> PED is greater than 1 => Change in demand is more than the change in price

Price inelastic => PED is less than 1 => Change in demand is less than the change in price

Unitary price elasticity => PED is exactly 1 => Change in demand = change in price.

If PED greater than 1, a change in price will cause a larger change in demand, so overall revenues would increase with a price cut, but drop with a price increase.

# Factors influencing PED

Income elasticity of demand-measures the extent to which the quantity of a product demanded is altered by a change in income.

Calculating income elasticity of demand (YED) is done using the formula:

% change in Quantity Demanded / % change in income


For inferior goods, demand falls as income rises, but increases as income declines.

PED: A(-1.5), B(-0.2) IED: A(0.5), B(-1.9) Negatives can be ignored here

PED: A is elastic, B is inelastic Y/IED: B is luxury(elastic), A is necessary (inelastic)

Limitations of calculating and using elasticities

Key evaluation points

Elastic products are more vulnerable to a decrease in demand if they increase their price. A price inelastic product will not notice much impact on demand if they increase prices.

Petrol’s elasticity depends on factors such as the number of nearby petrol stations, the need of customers to get petrol and various other factors. This means that petrol in a city would be fairly elastic, but fairly inelastic in the middle of nowhere.

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

Example of a product raising prices by 20%:

Price elasticity of demand measures the responsiveness of demand to a change in the price. We normally assume that a rise in price results in a fall in demand. The level of elasticity depends upon several factors including: the number of substitutes in the market which make it possible for customers to switch, whether the good is a necessity or a luxury and brand loyalty.