Elasticity

A general measure of the responsiveness of an economic variable in

response to a change in another economic variable

Written by CFI Team

Updated May 7, 2022

What is Elasticity?
Elasticity is a general measure of the responsiveness of an economic variable
in response to a change in another economic variable. Economists utilize
elasticity to gauge how variables affect each other. The three major forms of
elasticity are price elasticity of demand, cross-price elasticity of demand, and
income elasticity of demand.nm

Summary

 Elasticity is a general measure of the responsiveness of an economic variable

in response to a change in another economic variable.
 The three major forms of elasticity are price elasticity of demand, cross-price
elasticity of demand, and income elasticity of demand.
 The four factors that affect price elasticity of demand are (1) availability of
substitutes, (2) if the good is a luxury or a necessity, (3) the proportion of
income spent on the good, and (4) how much time has elapsed since the time
the price changed.
 If income elasticity is positive, the good is normal. If income elasticity is
negative, the good is inferior.

Price Elasticity of Demand

Price elasticity of demand demonstrates how a change in price affects the

quantity demanded. It is computed as the percentage change in quantity
demanded over the percentage change in price, and it will commonly result in
a negative elasticity because of the law of demand.

The law of demand states that an increase in price reduces the quantity
demanded, and it is why demand curves are downwards sloping unless the
good is a Giffen good. It is common to simply drop the negative of the
quotient.

The larger the price elasticity of demand, the more responsive quantity
demanded is given a change in price. When the price elasticity of demand is
greater than one, the good is considered to demonstrate elastic demand.
When the quantity demanded drops to zero with a rise in price, it is said that
demand is perfectly elastic. If the price of an elastic good increases, there is a
corresponding quantity effect, where fewer units are sold, and therefore
reducing revenue.
The lower the price elasticity of demand, the less responsive the quantity
demanded is given a change in price. When the price elasticity of demand is
less than one, the good is considered to show inelastic demand. When the
quantity demanded does not respond to a change in price, it is said that
demand is perfectly inelastic. If an inelastic good has its price increased, it will
lead to increased revenues because each unit will be sold at a higher price.

If a change in price comes with the same proportional change in the quantity
demanded, it is said that the good is unit elastic. Indicating that X% change in
price results in an X% change in the quantity demanded. Therefore, if the price
elasticity of demand equals one, the good is unit elastic. If a good shows a
unit elastic demand, the quantity effect and price effect exactly offset each
other.

Calculation of Price Elasticity of Demand through the Midpoint Method

The midpoint method is a commonly used technique to calculate the percent

change of price. The primary difference is that it calculates the percentage
change of quantity demanded and the price change relative to their average.

Examples of Goods with a Price Inelastic Demand

1. Beef
2. Gasoline
 3. Salt
4. Textbooks
5. Prescription drugs

Examples of Goods with a Price Elastic Demand

1. Housing
2. Furniture
3. Cars

Factors That Affect the Price Elasticity of Demand

1. Availability of close substitutes

If consumers can substitute the good for other readily available goods that
consumers regard as similar, then the price elasticity of demand would be
considered to be elastic. If consumers are unable to substitute a good, the
good would experience inelastic demand.

2. If the good is a necessity or a luxury

The price elasticity of demand is lower if the good is something the consumer
needs, such as Insulin. The price elasticity of demand tends to be higher if it is
a luxury good.

3. The proportion of income spent on the good

The price elasticity of demand tends to be low when spending on a good is a

small proportion of their available income. Therefore, a change in the price of
a good exerts a very little impact on the consumer’s propensity to
consume the good. Whereas, when a good represents a large chunk of the
consumer’s income, the consumer is said to possess a more elastic demand.

4. Time elapsed since a change in price

In the long term, consumers are more elastic over longer periods, as over the
long term after a price increase of a good, they will find acceptable and less
costly substitutes.
Other Demand Elasticities

1. Cross-Price Elasticity of Demand

The cross-price elasticity of demand measures how the demand for one good
is impacted by a change in the price of another good. It is calculated as the
percentage change of Quantity A divided by the percentage change in the
price of the other.

If the cross-price elasticity of demand between two goods is positive, it implies

that the two goods are substitutes. Consider the following substitute goods –
good A and good B. If the price of good B rises, the demand for good A rises.

On the contrary, if the aforementioned goods were complements, when the

price of good B increases, the demand for good A should decrease. It is what
is implied through the cross-price elasticity of demand formula. It is important
to note that the cross-price elasticity of demand is a unitless measure.

2. Income Elasticity of Demand

The income elasticity of demand is defined as the measure of the percentage

change of the quantity demanded of a good in reference to changes in the
consumer’s income. Calculating the income elasticity of demand allows
economists to identify normal and inferior goods, as well as how responsive
quantity demanded is to changes in income.
If the income elasticity of demand is positive, the good is considered to be a
normal good – implying that when income increases, the quantity demanded
at any given price increases.

If the income elasticity of demand is negative, the good is considered to be

an inferior good – implying that when income increases, the quantity
demanded at any given price decreases.

If the income elasticity of demand is higher than 1, then the good is

considered to be income elastic – implying that demand rises faster than
income. Luxury goods include international vacations or second homes.

If the income elasticity of demand is higher than 0 but less than 1, then the
good is income inelastic – implying that demand for income-inelastic goods
rises but at a slower rate than income.

Additional Resources

Thank you for reading CFI’s guide on Elasticity. To keep learning and
advancing your career, the following resources will be helpful:

 Free Economics for Capital Markets Course

 Aggregate Supply and Demand
 Normal Goods
 Demand Curve
 Unit Elastic
 5.1 The Price Elasticity of Demand
Learning Objectives

1. Explain the concept of price elasticity of demand and its calculation.

2. Explain what it means for demand to be price inelastic, unit price elastic, price elastic, perfectly price
inelastic, and perfectly price elastic.
3. Explain how and why the value of the price elasticity of demand changes along a linear demand curve.
4. Understand the relationship between total revenue and price elasticity of demand.
5. Discuss the determinants of price elasticity of demand.

We know from the law of demand how the quantity demanded will respond to a price change: it
will change in the opposite direction. But how much will it change? It seems reasonable to
expect, for example, that a 10% change in the price charged for a visit to the doctor would yield
a different percentage change in quantity demanded than a 10% change in the price of a Ford
Mustang. But how much is this difference?

To show how responsive quantity demanded is to a change in price, we apply the concept of
elasticity. The price elasticity of demand for a good or service, eD, is the percentage change in
quantity demanded of a particular good or service divided by the percentage change in the price
of that good or service, all other things unchanged. Thus we can write

Equation 5.2
eD=% change in quantity demanded% change in priceeD=% change in quantity demanded% change i
n price

Because the price elasticity of demand shows the responsiveness of quantity demanded to a price
change, assuming that other factors that influence demand are unchanged, it reflects
movements along a demand curve. With a downward-sloping demand curve, price and quantity
demanded move in opposite directions, so the price elasticity of demand is always negative. A
positive percentage change in price implies a negative percentage change in quantity demanded,
and vice versa. Sometimes you will see the absolute value of the price elasticity measure
reported. In essence, the minus sign is ignored because it is expected that there will be a negative
(inverse) relationship between quantity demanded and price. In this text, however, we will retain
the minus sign in reporting price elasticity of demand and will say “the absolute value of the
price elasticity of demand” when that is what we are describing.

Heads Up!

Be careful not to confuse elasticity with slope. The slope of a line is the change in
the value of the variable on the vertical axis divided by the change in the value of
the variable on the horizontal axis between two points. Elasticity is the ratio of the
percentage changes. The slope of a demand curve, for example, is the ratio of the
change in price to the change in quantity between two points on the curve. The
price elasticity of demand is the ratio of the percentage change in quantity to the
percentage change in price. As we will see, when computing elasticity at different
points on a linear demand curve, the slope is constant—that is, it does not change
—but the value for elasticity will change.

Computing the Price Elasticity of Demand

Finding the price elasticity of demand requires that we first compute percentage
changes in price and in quantity demanded. We calculate those changes between
two points on a demand curve.

Figure 5.1 “Responsiveness and Demand” shows a particular demand curve, a

linear demand curve for public transit rides. Suppose the initial price is $0.80, and
the quantity demanded is 40,000 rides per day; we are at point A on the curve.
Now suppose the price falls to $0.70, and we want to report the responsiveness of
the quantity demanded. We see that at the new price, the quantity demanded rises
to 60,000 rides per day (point B). To compute the elasticity, we need to compute
the percentage changes in price and in quantity demanded between points A and B.

Figure 5.1 Responsiveness and Demand

The demand curve shows how changes in price lead to changes in the quantity demanded. A movement from point A to point B
shows that a $0.10 reduction in price increases the number of rides per day by 20,000. A movement from B to A is a $0.10
increase in price, which reduces quantity demanded by 20,000 rides per day.

We measure the percentage change between two points as the change in the
variable divided by the average value of the variable between the two points. Thus,
the percentage change in quantity between points A and B in Figure 5.1
“Responsiveness and Demand” is computed relative to the average of the quantity
values at points A and B: (60,000 + 40,000)/2 = 50,000. The percentage change in
quantity, then, is 20,000/50,000, or 40%. Likewise, the percentage change in price
between points A and B is based on the average of the two prices: ($0.80 +
$0.70)/2 = $0.75, and so we have a percentage change of −0.10/0.75, or −13.33%.
The price elasticity of demand between points A and B is thus 40%/(−13.33%) =
−3.00.

This measure of elasticity, which is based on percentage changes relative to the

average value of each variable between two points, is called arc elasticity. The arc
elasticity method has the advantage that it yields the same elasticity whether we go
from point A to point B or from point B to point A. It is the method we shall use to
compute elasticity.
For the arc elasticity method, we calculate the price elasticity of demand using the
average value of price,¯PP¯, and the average value of quantity demanded,¯QQ¯.
We shall use the Greek letter Δ to mean “change in,” so the change in quantity
between two points is ΔQ and the change in price is ΔP. Now we can write the
formula for the price elasticity of demand as
Equation 5.3
eD=ΔQ/¯QΔP/¯PeD=ΔQ/Q¯ΔP/P¯

The price elasticity of demand between points A and B is thus:

eD=20,000(40,000+60,000)/2−$0.10($0.80+$0.70)/2=40%−13.33%=−3.00eD=20,000(40,000+60,000)/2−
$0.10($0.80+$0.70)/2=40%−13.33%=−3.00

With the arc elasticity formula, the elasticity is the same whether we move from
point A to point B or from point B to point A. If we start at point B and move to
point A, we have:
eD=−20,000(60,000+40,000)/2$0.10($0.80+$0.70)/2=−40%13.33%=−3.00eD=−20,000(60,000+40,000)/
2$0.10($0.80+$0.70)/2=−40%13.33%=−3.00

The arc elasticity method gives us an estimate of elasticity. It gives the value of
elasticity at the midpoint over a range of change, such as the movement between
points A and B. For a precise computation of elasticity, we would need to consider
the response of a dependent variable to an extremely small change in an
independent variable. The fact that arc elasticities are approximate suggests an
important practical rule in calculating arc elasticities: we should consider only
small changes in independent variables. We cannot apply the concept of arc
elasticity to large changes.

Another argument for considering only small changes in computing price

elasticities of demand will become evident in the next section. We will investigate
what happens to price elasticities as we move from one point to another along a
linear demand curve.

Heads Up!

Notice that in the arc elasticity formula, the method for computing a percentage
change differs from the standard method with which you may be familiar. That
method measures the percentage change in a variable relative to its original value.
For example, using the standard method, when we go from point A to point B, we
would compute the percentage change in quantity as 20,000/40,000 = 50%. The
percentage change in price would be −$0.10/$0.80 = −12.5%. The price elasticity
of demand would then be 50%/(−12.5%) = −4.00. Going from point B to point A,
however, would yield a different elasticity. The percentage change in quantity
would be −20,000/60,000, or −33.33%. The percentage change in price would be
$0.10/$0.70 = 14.29%. The price elasticity of demand would thus be
−33.33%/14.29% = −2.33. By using the average quantity and average price to
calculate percentage changes, the arc elasticity approach avoids the necessity to
specify the direction of the change and, thereby, gives us the same answer whether
we go from A to B or from B to A.

Price Elasticities Along a Linear Demand

Curve
What happens to the price elasticity of demand when we travel along the demand
curve? The answer depends on the nature of the demand curve itself. On a linear
demand curve, such as the one in Figure 5.2 “Price Elasticities of Demand for a
Linear Demand Curve”, elasticity becomes smaller (in absolute value) as we travel
downward and to the right.

Figure 5.2 Price Elasticities of Demand for a Linear Demand Curve

The price elasticity of demand varies between different pairs of points along a linear demand curve. The lower the price and the
greater the quantity demanded, the lower the absolute value of the price elasticity of demand.

Figure 5.2 “Price Elasticities of Demand for a Linear Demand Curve” shows the
same demand curve we saw in Figure 5.1 “Responsiveness and Demand”. We have
already calculated the price elasticity of demand between points A and B; it equals
−3.00. Notice, however, that when we use the same method to compute the price
elasticity of demand between other sets of points, our answer varies. For each of
the pairs of points shown, the changes in price and quantity demanded are the same
(a $0.10 decrease in price and 20,000 additional rides per day, respectively). But at
the high prices and low quantities on the upper part of the demand curve, the
percentage change in quantity is relatively large, whereas the percentage change in
price is relatively small. The absolute value of the price elasticity of demand is thus
relatively large. As we move down the demand curve, equal changes in quantity
represent smaller and smaller percentage changes, whereas equal changes in price
represent larger and larger percentage changes, and the absolute value of the
elasticity measure declines. Between points C and D, for example, the price
elasticity of demand is −1.00, and between points E and F the price elasticity of
demand is −0.33.

On a linear demand curve, the price elasticity of demand varies depending on the
interval over which we are measuring it. For any linear demand curve, the absolute
value of the price elasticity of demand will fall as we move down and to the right
along the curve.

The Price Elasticity of Demand and Changes

in Total Revenue
Suppose the public transit authority is considering raising fares. Will its total
revenues go up or down? Total revenue is the price per unit times the number of
units sold1. In this case, it is the fare times the number of riders. The transit
authority will certainly want to know whether a price increase will cause its total
revenue to rise or fall. In fact, determining the impact of a price change on total
revenue is crucial to the analysis of many problems in economics.

We will do two quick calculations before generalizing the principle involved.

Given the demand curve shown in Figure 5.2 “Price Elasticities of Demand for a
Linear Demand Curve”, we see that at a price of $0.80, the transit authority will
sell 40,000 rides per day. Total revenue would be $32,000 per day ($0.80 times
40,000). If the price were lowered by $0.10 to $0.70, quantity demanded would
increase to 60,000 rides and total revenue would increase to $42,000 ($0.70 times
60,000). The reduction in fare increases total revenue. However, if the initial price
had been $0.30 and the transit authority reduced it by $0.10 to $0.20, total revenue
would decrease from $42,000 ($0.30 times 140,000) to $32,000 ($0.20 times
160,000). So it appears that the impact of a price change on total revenue depends
on the initial price and, by implication, the original elasticity. We generalize this
point in the remainder of this section.

The problem in assessing the impact of a price change on total revenue of a good
or service is that a change in price always changes the quantity demanded in the
opposite direction. An increase in price reduces the quantity demanded, and a
reduction in price increases the quantity demanded. The question is how much.
Because total revenue is found by multiplying the price per unit times the quantity
demanded, it is not clear whether a change in price will cause total revenue to rise
or fall.

We have already made this point in the context of the transit authority. Consider
the following three examples of price increases for gasoline, pizza, and diet cola.

Suppose that 1,000 gallons of gasoline per day are demanded at a price of $4.00
per gallon. Total revenue for gasoline thus equals $4,000 per day (=1,000 gallons
per day times $4.00 per gallon). If an increase in the price of gasoline to $4.25
reduces the quantity demanded to 950 gallons per day, total revenue rises to
$4,037.50 per day (=950 gallons per day times $4.25 per gallon). Even though
people consume less gasoline at $4.25 than at $4.00, total revenue rises because the
higher price more than makes up for the drop in consumption.

Next consider pizza. Suppose 1,000 pizzas per week are demanded at a price of $9
per pizza. Total revenue for pizza equals $9,000 per week (=1,000 pizzas per week
times $9 per pizza). If an increase in the price of pizza to $10 per pizza reduces
quantity demanded to 900 pizzas per week, total revenue will still be $9,000 per
week (=900 pizzas per week times $10 per pizza). Again, when price goes up,
consumers buy less, but this time there is no change in total revenue.

Now consider diet cola. Suppose 1,000 cans of diet cola per day are demanded at a
price of $0.50 per can. Total revenue for diet cola equals $500 per day (=1,000
cans per day times $0.50 per can). If an increase in the price of diet cola to $0.55
per can reduces quantity demanded to 880 cans per month, total revenue for diet
cola falls to $484 per day (=880 cans per day times $0.55 per can). As in the case
of gasoline, people will buy less diet cola when the price rises from $0.50 to $0.55,
but in this example total revenue drops.

In our first example, an increase in price increased total revenue. In the second, a
price increase left total revenue unchanged. In the third example, the price rise
reduced total revenue. Is there a way to predict how a price change will affect total
revenue? There is; the effect depends on the price elasticity of demand.

Elastic, Unit Elastic, and Inelastic Demand

To determine how a price change will affect total revenue, economists place price
elasticities of demand in three categories, based on their absolute value. If the
absolute value of the price elasticity of demand is greater than 1, demand is
termed price elastic. If it is equal to 1, demand is unit price elastic. And if it is less
than 1, demand is price inelastic.

Relating Elasticity to Changes in Total

Revenue
When the price of a good or service changes, the quantity demanded changes in the
opposite direction. Total revenue will move in the direction of the variable that
changes by the larger percentage. If the variables move by the same percentage,
total revenue stays the same. If quantity demanded changes by a larger percentage
than price (i.e., if demand is price elastic), total revenue will change in the
direction of the quantity change. If price changes by a larger percentage than
quantity demanded (i.e., if demand is price inelastic), total revenue will move in
the direction of the price change. If price and quantity demanded change by the
same percentage (i.e., if demand is unit price elastic), then total revenue does not
change.

When demand is price inelastic, a given percentage change in price results in a

smaller percentage change in quantity demanded. That implies that total revenue
will move in the direction of the price change: a reduction in price will reduce total
revenue, and an increase in price will increase it.

Consider the price elasticity of demand for gasoline. In the example above, 1,000
gallons of gasoline were purchased each day at a price of $4.00 per gallon; an
increase in price to $4.25 per gallon reduced the quantity demanded to 950 gallons
per day. We thus had an average quantity of 975 gallons per day and an average
price of $4.125. We can thus calculate the arc price elasticity of demand for
gasoline:

Percentage change in quantity demanded = -
50/975 = -5.1%

Percentage change in price=0.25/4.125=6.06%
Price elasticity of demand = -5.1%/6.06% =
-.084

The demand for gasoline is price inelastic, and total revenue moves in the direction
of the price change. When price rises, total revenue rises. Recall that in our
example above, total spending on gasoline (which equals total revenues to sellers)
rose from $4,000 per day (=1,000 gallons per day times $4.00) to $4037.50 per day
(=950 gallons per day times $4.25 per gallon).

When demand is price inelastic, a given percentage change in price results in a

smaller percentage change in quantity demanded. That implies that total revenue
will move in the direction of the price change: an increase in price will increase
total revenue, and a reduction in price will reduce it.

Consider again the example of pizza that we examined above. At a price of $9 per
pizza, 1,000 pizzas per week were demanded. Total revenue was $9,000 per week
(=1,000 pizzas per week times $9 per pizza). When the price rose to $10, the
quantity demanded fell to 900 pizzas per week. Total revenue remained $9,000 per
week (=900 pizzas per week times $10 per pizza). Again, we have an average
quantity of 950 pizzas per week and an average price of $9.50. Using the arc
elasticity method, we can compute:
Percentage change in quantity demanded = -100/950 = -10.5%

Percentage change in price = $1.00/$9.50 = 10.5%

Price elasticity of demand = -10.5%/10.5% = -1.0

Demand is unit price elastic, and total revenue remains unchanged. Quantity
demanded falls by the same percentage by which price increases.

Consider next the example of diet cola demand. At a price of $0.50 per can, 1,000
cans of diet cola were purchased each day. Total revenue was thus $500 per day
(=$0.50 per can times 1,000 cans per day). An increase in price to $0.55 reduced
the quantity demanded to 880 cans per day. We thus have an average quantity of
940 cans per day and an average price of $0.525 per can. Computing the price
elasticity of demand for diet cola in this example, we have:
Percentage change in quantity demanded = -120/940 = -12.8%
Percentage change in price = $0.05/$0.525 = 9.5%

Price elasticity of demand = -12.8%/9.5% = -1.3

The demand for diet cola is price elastic, so total revenue moves in the direction of
the quantity change. It falls from $500 per day before the price increase to $484
per day after the price increase.

A demand curve can also be used to show changes in total revenue. Figure 5.3
“Changes in Total Revenue and a Linear Demand Curve” shows the demand curve
from Figure 5.1 “Responsiveness and Demand” and Figure 5.2 “Price Elasticities
of Demand for a Linear Demand Curve”. At point A, total revenue from public
transit rides is given by the area of a rectangle drawn with point A in the upper
right-hand corner and the origin in the lower left-hand corner. The height of the
rectangle is price; its width is quantity. We have already seen that total revenue at
point A is $32,000 ($0.80 × 40,000). When we reduce the price and move to point
B, the rectangle showing total revenue becomes shorter and wider. Notice that the
area gained in moving to the rectangle at B is greater than the area lost; total
revenue rises to $42,000 ($0.70 × 60,000). Recall from Figure 5.2 “Price
Elasticities of Demand for a Linear Demand Curve” that demand is elastic between
points A and B. In general, demand is elastic in the upper half of any linear
demand curve, so total revenue moves in the direction of the quantity change.

Figure 5.3 Changes in Total Revenue and a Linear Demand Curve

 Moving from point A to point B implies a reduction in price and an increase in the quantity demanded. Demand is elastic
between these two points. Total revenue, shown by the areas of the rectangles drawn from points A and B to the origin, rises.
When we move from point E to point F, which is in the inelastic region of the demand curve, total revenue falls.

A movement from point E to point F also shows a reduction in price and an

increase in quantity demanded. This time, however, we are in an inelastic region of
the demand curve. Total revenue now moves in the direction of the price change—
it falls. Notice that the rectangle drawn from point F is smaller in area than the
rectangle drawn from point E, once again confirming our earlier calculation.

Figure 5.4

We have noted that a linear demand curve is more elastic where prices are relatively high and quantities relatively low and less
elastic where prices are relatively low and quantities relatively high. We can be even more specific. For any linear demand curve,
demand will be price elastic in the upper half of the curve and price inelastic in its lower half. At the midpoint of a linear demand
curve, demand is unit price elastic.
Constant Price Elasticity of Demand Curves
Figure 5.5 “Demand Curves with Constant Price Elasticities” shows four demand
curves over which price elasticity of demand is the same at all points. The demand
curve in Panel (a) is vertical. This means that price changes have no effect on
quantity demanded. The numerator of the formula given in Equation 5.2 for the
price elasticity of demand (percentage change in quantity demanded) is zero. The
price elasticity of demand in this case is therefore zero, and the demand curve is
said to be perfectly inelastic. This is a theoretically extreme case, and no good that
has been studied empirically exactly fits it. A good that comes close, at least over a
specific price range, is insulin. A diabetic will not consume more insulin as its
price falls but, over some price range, will consume the amount needed to control
the disease.

Figure 5.5 Demand Curves with Constant Price Elasticities

The demand curve in Panel (a) is perfectly inelastic. The demand curve in Panel (b) is perfectly elastic. Price elasticity of demand
is −1.00 all along the demand curve in Panel (c), whereas it is −0.50 all along the demand curve in Panel (d).

As illustrated in Figure 5.5 “Demand Curves with Constant Price Elasticities”,

several other types of demand curves have the same elasticity at every point on
them. The demand curve in Panel (b) is horizontal. This means that even the
smallest price changes have enormous effects on quantity demanded. The
denominator of the formula given in Equation 5.2 for the price elasticity of demand
(percentage change in price) approaches zero. The price elasticity of demand in
this case is therefore infinite, and the demand curve is said to be perfectly elastic.
This is the type of demand curve faced by producers of standardized products such
as wheat. If the wheat of other farms is selling at $4 per bushel, a typical farm can
sell as much wheat as it wants to at $4 but nothing at a higher price and would
have no reason to offer its wheat at a lower price.

The nonlinear demand curves in Panels (c) and (d) have price elasticities of
demand that are negative; but, unlike the linear demand curve discussed above, the
value of the price elasticity is constant all along each demand curve. The demand
curve in Panel (c) has price elasticity of demand equal to −1.00 throughout its
range; in Panel (d) the price elasticity of demand is equal to −0.50 throughout its
range. Empirical estimates of demand often show curves like those in Panels (c)
and (d) that have the same elasticity at every point on the curve.

Heads Up!

Do not confuse price inelastic demand and perfectly inelastic demand. Perfectly
inelastic demand means that the change in quantity is zero for any percentage
change in price; the demand curve in this case is vertical. Price inelastic demand
means only that the percentage change in quantity is less than the percentage
change in price, not that the change in quantity is zero. With price inelastic (as
opposed to perfectly inelastic) demand, the demand curve itself is still downward
sloping.

Determinants of the Price Elasticity of Demand

The greater the absolute value of the price elasticity of demand, the greater the
responsiveness of quantity demanded to a price change. What determines whether
demand is more or less price elastic? The most important determinants of the price
elasticity of demand for a good or service are the availability of substitutes, the
importance of the item in household budgets, and time.

Availability of Substitutes
The price elasticity of demand for a good or service will be greater in absolute
value if many close substitutes are available for it. If there are lots of substitutes for
a particular good or service, then it is easy for consumers to switch to those
substitutes when there is a price increase for that good or service. Suppose, for
example, that the price of Ford automobiles goes up. There are many close
substitutes for Fords—Chevrolets, Chryslers, Toyotas, and so on. The availability
of close substitutes tends to make the demand for Fords more price elastic.

If a good has no close substitutes, its demand is likely to be somewhat less price
elastic. There are no close substitutes for gasoline, for example. The price elasticity
of demand for gasoline in the intermediate term of, say, three–nine months is
generally estimated to be about −0.5. Since the absolute value of price elasticity is
less than 1, it is price inelastic. We would expect, though, that the demand for a
particular brand of gasoline will be much more price elastic than the demand for
gasoline in general.

Importance in Household Budgets

One reason price changes affect quantity demanded is that they change how much
a consumer can buy; a change in the price of a good or service affects the
purchasing power of a consumer’s income and thus affects the amount of a good
the consumer will buy. This effect is stronger when a good or service is important
in a typical household’s budget.

A change in the price of jeans, for example, is probably more important in your
budget than a change in the price of pencils. Suppose the prices of both were to
double. You had planned to buy four pairs of jeans this year, but now you might
decide to make do with two new pairs. A change in pencil prices, in contrast, might
lead to very little reduction in quantity demanded simply because pencils are not
likely to loom large in household budgets. The greater the importance of an item in
household budgets, the greater the absolute value of the price elasticity of demand
is likely to be.

Time
Suppose the price of electricity rises tomorrow morning. What will happen to the
quantity demanded?

The answer depends in large part on how much time we allow for a response. If we
are interested in the reduction in quantity demanded by tomorrow afternoon, we
can expect that the response will be very small. But if we give consumers a year to
respond to the price change, we can expect the response to be much greater. We
expect that the absolute value of the price elasticity of demand will be greater
when more time is allowed for consumer responses.

Consider the price elasticity of crude oil demand. Economist John C. B. Cooper
estimated short- and long-run price elasticities of demand for crude oil for 23
industrialized nations for the period 1971–2000. Professor Cooper found that for
virtually every country, the price elasticities were negative, and the long-run price
elasticities were generally much greater (in absolute value) than were the short-run
price elasticities. His results are reported in Table 5.1 “Short- and Long-Run Price
Elasticities of the Demand for Crude Oil in 23 Countries”. As you can see, the
research was reported in a journal published by OPEC (Organization of Petroleum
Exporting Countries), an organization whose members have profited greatly from
the inelasticity of demand for their product. By restricting supply, OPEC, which
produces about 45% of the world’s crude oil, is able to put upward pressure on the
price of crude. That increases OPEC’s (and all other oil producers’) total revenues
and reduces total costs.

Table 5.1 Short- and Long-Run Price Elasticities of the Demand for Crude Oil in 23 Countries

Short-Run Price Elasticity of

Country Long-Run Price Elasticity of Demand
Demand

Australia −0.034 −0.068

Austria −0.059 −0.092

Canada −0.041 −0.352

China 0.001 0.005

Denmark −0.026 −0.191

Finland −0.016 −0.033

France −0.069 −0.568

 Short-Run Price Elasticity of
Country Long-Run Price Elasticity of Demand
Demand

Germany −0.024 −0.279

Greece −0.055 −0.126

Iceland −0.109 −0.452

Ireland −0.082 −0.196

Italy −0.035 −0.208

Japan −0.071 −0.357

Korea −0.094 −0.178

Netherlands −0.057 −0.244

 Short-Run Price Elasticity of
Country Long-Run Price Elasticity of Demand
Demand

New Zealand −0.054 −0.326

Norway −0.026 −0.036

Portugal 0.023 0.038

Spain −0.087 −0.146

Sweden −0.043 −0.289

Switzerland −0.030 −0.056

United Kingdom −0.068 −0.182

United States −0.061 −0.453

For most countries, price elasticity of demand for crude oil tends to be greater (in absolute value) in the
long run than in the short run.
Source: John C. B. Cooper, “Price Elasticity of Demand for Crude Oil: Estimates from 23
Countries,” OPEC Review: Energy Economics & Related Issues, 27:1 (March 2003): 4. The estimates are
based on data for the period 1971–2000, except for China and South Korea, where the period is 1979–
 2000. While the price elasticities for China and Portugal were positive, they were not statistically
significant.
Key Takeaways
 The price elasticity of demand measures the responsiveness of quantity demanded to
changes in price; it is calculated by dividing the percentage change in quantity demanded
by the percentage change in price.
 Demand is price inelastic if the absolute value of the price elasticity of demand is less than
1; it is unit price elastic if the absolute value is equal to 1; and it is price elastic if the
absolute value is greater than 1.
 Demand is price elastic in the upper half of any linear demand curve and price inelastic in
the lower half. It is unit price elastic at the midpoint.
 When demand is price inelastic, total revenue moves in the direction of a price change.
When demand is unit price elastic, total revenue does not change in response to a price
change. When demand is price elastic, total revenue moves in the direction of a quantity
change.
 The absolute value of the price elasticity of demand is greater when substitutes are
available, when the good is important in household budgets, and when buyers have more
time to adjust to changes in the price of the good.