In economics, the elasticity of demand measures how sensitive the demand for a product or service is to price fluctuations. Typically when the price of a good or service decreases, the demand for it increases and sales volume increases with it. By the same token, when the price for a good or service increases, the demand for it decreases and sales volume decreases with it. The measure called price elastic of demand (PED) uses a mathematical formula to determine which products have elastic demand and which ones have inelastic demand.
Calculating Price Elastic of Demand
Products whose sales volumes change more with price shifts are considered to have elastic demand. Goods and services whose sales volumes change little with price alterations are considered to have inelastic demand. To calculate how elastic or inelastic a product is, the percent change in price is divided from the percentage change in quantity demanded. So if sales decrease 40 percent because the price of a good increases 20 percent, the formula is -40 percent divided by 20 percent. The price elasticity of demand is measured at -2.
Elastic Versus Inelastic Demand in Economics
If a PED is measured at less than 1, it is labeled inelastic. If the PED is greater than 1, it is categorized as elastic. If the PED equals 0, it is considered perfectly elastic. Luxury goods tend to have a greater elasticity of demand than necessities. The availability of substitutes also influences how elastic or inelastic a product is because the more substitutes that exist for a product, the greater its elasticity. With the passage of time, products tend to become more elastic because consumers have the opportunity to adjust their spending patterns.