Elasticity of Demand Formula: Definition and How to Use It

By Indeed Editorial Team

Published 24 June 2022

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The elasticity of demand can help businesses expect changes in demand contingent on various factors, including market trends and price changes. Many companies have dedicated professionals who perform this calculation for review by stakeholders and upper management. If you're interested in learning about the elasticity of demand, it's first important to be familiar with the elasticity of demand formula. In this article, we explore what the elasticity of demand is, provide the formula for calculating this demand, provide steps on how to use the formula and provide example calculations.

Related: Elastic vs. Inelastic Demand: With Types and Differences

What is the elasticity of demand formula?

Companies use the elasticity of demand formula to identify and track the demand for a product or service when compared to various factors. Many professionals frequently use price to measure the elasticity of demand, so some people refer to this metric as price elasticity of demand. This formula allows organisations to anticipate changes in demand dependent on factors like the market entry of similar goods and price changes. Elastic goods are those that have a significant shift in demand after a change in price.

Types of elasticity of demand

Here are the different types of elasticity of demand you can calculate:

  • Substitute: This refers to when there are substitutes for goods or services. The more competing options there are for products, the more elastic they usually are.

  • Income: Also known as the income effect, this type of elasticity of demand refers to the earning potential of a certain population. The income level of a population can affect the elasticity of services and goods.

  • Price: Price is the most common factor that companies may use to measure the elasticity of a good or service. You can determine the price elasticity of demand by dividing the proportional change of purchases by the proportional price change.

Elastic products are usually those that aren't a necessity. For example, a particular type of car is not a necessity if other vehicles are available. If prices change on these products, people may simply purchase other similar products at a lower price.

Related: What Is Price Elasticity of Demand? (Plus Formula)

Steps for calculating the elasticity of demand

The elasticity of demand formula relies on the measurement of elasticity of demand dependent on price. The formula for determining this measurement is:

Price elasticity of demand = Percentage change in quantity / Percentage change in price

Here are steps you can follow to calculate the elasticity of demand:

1. Identify the price and quantity

The first step for calculating the elasticity of demand is to identify the percentage change in quantity and the percentage change in price. It's also important to set the period you're analysing to ensure you're comparing relevant. The price and demand at the beginning of a period are your initial figures and the price and demand at the end of a period are your final figures.

2. Determine the numerator

Determine the numerator of the formula, which is a representation of the percentage change in quantity. You can find this by determining the difference between the final quantities and initial quantities of demand. Subtract the final quantities by the initial quantities to get the numerical difference. Divide this number by the initial quantities of demand to get the percentage change.

3. Find the denominator

The next step is to determine the denominator of the formula, which is a representation of the overall percentage change in price. Subtract the final price from the initial price to get the numerical price difference. Divide this result by the initial price to get the percentage change in price.

4. Divide numerator by denominator

Once you've calculated the percentage changes in quantity and price, you can finish the calculation. Divide the percentage change in quantity by the percentage change in price to get the price elasticity of demand. The result may be negative if there's a negative change in price or quantity. If the result is between negative one and one, it shows that a product is inelastic. A result greater than one or less than negative one shows that a product is elastic.

Examples

Here are some examples of calculating the elasticity of demand:

Soda company

Here's an example of assessing the elasticity of a soda brand after they raised prices:

A particular brand of soda's prices has gone up by 45%, resulting in a decline in purchases by 15%. You can calculate the elasticity of demand as follows:

15% / 45% = 3

Being greater than one shows that the soda brand is an elastic product.

Clothing company

Here's an example of assessing the elasticity of a clothing brand after they reduce prices:

A company sells shirts at $150, and consumers purchase around 3,000 t-shirts each month. The company wants to increase sales, so it reduces the price of its t-shirts to $130, which increases sales to 4,000 t-shirts per month. You can calculate the elasticity of demand as follows:

((4,000 - 3,000) / 3000) / (($130 - $150) / $150) = -2.5

You can consider this company's t-shirts to be an elastic product as the result is less than negative one.

Gasoline

The cost of gasoline has risen by 45% over the last month, which has caused a decline in gasoline purchases by consumers by 10%. Using the elasticity of demand formula, you can calculate price elasticity as follows:

-10% / 45% = 0.22

This result shows that gasoline is an inelastic product, likely because it's a necessity for many people and businesses.

Business uses of elasticity of demand

It's important for organisations to understand how price elasticity of demand works. Tracking these metrics helps a company have a better understanding of the relationship between the demand for a product and its price. The elasticity of demand can help companies determine their pricing policy in various markets and with different services and products. This helps them understand the effects of changing the price of their products to make more informed pricing decisions.

6 jobs that may calculate the elasticity of demand

The following are a few jobs in which determining elasticity of demand is necessary:

1. Strategy consultant

Average base salary: $289,472 per year

Primary duties: Strategy consultants have various responsibilities related to assisting companies in staying competitive in their market. They may use the formula for the elasticity of demand to determine prices and quantities of goods. Other duties may include meeting with clients to go over primary objectives and goals, studying marketing behaviour and creating strategies to reduce costs and increase revenue.

2. Junior data scientist

Average base salary: $366,190 per year

Primary duties: Junior data scientists are data professionals who extract data from various sources. They may calculate the elasticity of demand from market data to determine the price elasticity of a product. Data scientists then show upper management and stakeholders their findings so they can make educated decisions.

3. Category manager

Average base salary: $477,091 per year

Primary duties: Category managers often oversee various segments within an organisation and manage other category employees. They're often responsible for the pricing of products, and they calculate the elasticity of demand to determine the positioning of products. Other duties include creating long-term strategies for different product categories, devising exit strategies for products that don't succeed and studying consumer trends.

4. Product manager

Average base salary: $489,264 per year

Primary duties: A product manager is an expert in company products and handles the success of a product launch and revenue brought in by the new product. They may use the formula for the elasticity of demand to determine current product prices and needs and then incorporate this information into their strategies. Other duties may include overseeing a cross-functional team working on a product, forecasting marketing trends and defining a product.

Related: What Is a Product Manager? (Plus Steps, Skills and FAQs)

5. Pricing specialist

Average base salary: $658,409 per year

Primary duties: Pricing specialists help companies identify the best value and pricing for a company's services and goods. They assess market trends and perform statistical analysis. They may calculate the elasticity of demand to determine the competitive pricing range of a product and how that may affect a company's sales.

6. Pricing analyst

Average base salary: $658,409 per year

Primary duties: Pricing analysts work to assist companies in deciding on competitive pricing strategies to reach sales goals. They analyse data from various sources, such as the elasticity of demand for a product. Other duties may include creating elaborate pricing models, working with marketing and sales teams to develop sales strategies and using statistical modelling methods to realise the impact that a pricing strategy may have on profitability.

Salary figures reflect data listed on Indeed Salaries at the time of writing. Salaries may vary depending on the hiring organisation and a candidate's experience, academic background and location.

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