Price elasticity of demand

In one paragraph

Elasticity measures how sensitive your customers are to price. If a small rise loses you a lot of sales, demand is elastic. If it barely dents them, it is inelastic.

PED = % change in quantity demanded ÷ % change in price

The result is normally negative, because raising price reduces demand; it is the size that matters. Greater than 1 (ignoring the sign) is elastic — demand responds strongly. Less than 1 is inelastic — demand barely moves.

Why it decides your pricing

If demand is inelastic, raising prices increases total revenue: you lose fewer sales proportionally than the price you gained. If demand is elastic, raising prices reduces total revenue, and cutting them can increase it.

Demand tends to be inelastic where there are few substitutes, the item is a small part of the customer's spending, it is a necessity, or the brand is strong. It tends to be elastic where alternatives are easy and comparison is simple.

This is why price cuts so often destroy profit. Contribution falls immediately and with certainty; the extra volume is a hope.

How to actually use it

• Test rather than calculate. Raise the price on one product or for new customers and watch what actually happens to volume — real elasticity beats an estimate.
• Work out the volume you would need to stand still after a discount. On a 40% gross margin, a 10% price cut needs roughly a third more sales just to break even.

Where it breaks down

• Elasticity is not fixed. It differs by customer segment, by season and over time — short-run demand for petrol is inelastic, long-run demand much less so.
• It assumes everything else stays equal, which in a competitive market it does not: rivals respond.

If you are being examined on it

State the formula, get the sign convention right, and link the answer to what happens to *revenue*. That link is what is being tested.

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