Elas­tic­ity of demand (ED) mea­sures how much demand changes when the price or another fac­tor changes. It com­pares the per­cent­age change in demand with the per­cent­age change in the fac­tor that caused it. The most com­mon case is a change in price: elas­tic­ity then tells us how strongly buy­ers react to that price change. Elas­tic­ity of demand mat­ters because it:

  • helps busi­nesses fix the price of their prod­ucts
  • helps in max­imis­ing prof­its
  • helps in pric­ing a sub­sti­tute
  • helps busi­nesses decide how to allo­cate the cost of pro­duc­tion

Elas­tic­ity of demand for­mula

The elas­tic­ity of demand is mea­sured with a sim­ple for­mula:

Elas­tic­ity of demand = % change in the quan­tity demanded / % change in the fac­tors affect­ing demand

Writ­ten out in full, this becomes

Elas­tic­ity = [(Change in quan­tity demanded / Orig­i­nal quan­tity) × 100] / [(Change in the fac­tor affect­ing demand / Orig­i­nal value of the fac­tor) × 100]

= (Change in quan­tity demanded / Orig­i­nal quan­tity) × (Orig­i­nal value of the fac­tor / Change in the fac­tor)

Key terms

Elas­tic­ity of Demand (ED)
Elas­tic­ity of demand refers to the shift in demand for an item or ser­vice when a change occurs in one of the vari­ables that buy­ers con­sider as part of their pur­chase deci­sions. It's a rela­tion­ship between demand and another vari­able, such as price, avail­abil­ity of sub­sti­tutes, adver­tis­ing pres­sure and cus­tomer income.
Price Elas­tic­ity of Demand (PED)
The price elas­tic­ity of demand is the per­cent­age change in the quan­tity demanded of a good or ser­vice divided by the per­cent­age change in the price.
Income Elas­tic­ity of Demand (YED)
Income elas­tic­ity of demand mea­sures the degree of respon­sive­ness of demand to a change in con­sumer income, that is, the ratio of the per­cent­age change in quan­tity demanded to the per­cent­age change in income.
Cross Elas­tic­ity of Demand (XED)
The cross (or cross-price) elas­tic­ity of demand mea­sures the effect of changes in the price of one good on the quan­tity demanded of another good.

Com­mon ques­tions

What is demand func­tion?

A demand func­tion is a math­e­mat­i­cal func­tion describ­ing the rela­tion­ship between a vari­able, like the demand of quan­tity, and var­i­ous fac­tors deter­min­ing the demand. The pur­pose of this func­tion is to ana­lyze the behav­ior of con­sumers in a mar­ket and to help firms make pric­ing deci­sions.

What is the aggre­gate demand func­tion?

The aggre­gate func­tion of demand refers to an eco­nomic con­cept that shows the total demand for goods and ser­vices within an econ­omy at a given price level for a spe­cific period.

What is adver­tis­ing elas­tic­ity of demand?

The adver­tis­ing elas­tic­ity of demand (AED) is a mea­sure of a mar­ket's sen­si­tiv­ity to increases or decreases in adver­tis­ing sat­u­ra­tion. The elas­tic­ity of an adver­tis­ing cam­paign is mea­sured by its abil­ity to gen­er­ate new sales.

Pos­i­tive adver­tis­ing elas­tic­ity means that an uptick in adver­tis­ing leads to an increase in demand for the goods or ser­vices adver­tised. A suc­cess­ful adver­tis­ing cam­paign will lead to a pos­i­tive shift in demand for a good.

How is elas­tic­ity mea­sured?

As a ratio of two per­cent­ages. For price elas­tic­ity, it is the per­cent­age change in quan­tity demanded divided by the per­cent­age change in price.

What is inelas­tic­ity of demand?

Demand is inelas­tic when the quan­tity demanded changes only a lit­tle, pro­por­tion­ately less than the price, when the price changes.

Inelas­tic prod­ucts are usu­ally neces­si­ties with­out accept­able sub­sti­tutes. The most com­mon goods with inelas­tic demand are util­i­ties, pre­scrip­tion drugs, and tobacco prod­ucts.

Busi­nesses offer­ing such prod­ucts main­tain greater flex­i­bil­ity with prices because demand changes lit­tle even when prices rise or fall. In gen­eral, neces­si­ties and med­ical treat­ments tend to be inelas­tic, while lux­ury goods tend to be most elas­tic.