Explaining Elasticity of demand - Law of Demand

Elasticity of Demand

Elasticity of demand is the responsiveness of the demand for a good or service to the increase or decrease in its price. It is often shown in the form of a ratio between price and demand. For example, if the price of candy bars rise by 1% and the quantity demanded falls by 2.6%, then candy bar demand is very price elastic. Price elasticity (PE) of demand is -2.6. If price did not impact sales then it could be said that candy bars are price inelastic. This would not be the case because there are many candy bar substitute products available on the market.

The law of demand states that if all other factors are equal, as the price of a good or service increases, the consumer demand for the good or service will decrease and vice versa. For example, consumers will purchase more candy bars if the price of candy bar falls. The opposite is true if the price of candy bars increases. In order to determine if the candy bar could be increased in price estimations could be made using current elasticity. The formula for Price Elasticity is

PE= % Change in Quantity Demanded\% Change in Price

If you know the current PE and if you have historical data such as prior pricing and quantities then changes in price percentage could be used to determine trends and show how a price change might impact sales. Another strategy would be to increase price in small increments and track the PE.

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