What Is Elastic Demand?
By Indeed Editorial Team
Updated March 31, 2021 | Published January 13, 2021
Updated March 31, 2021
Published January 13, 2021
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
The relationship between demand and price can help business owners and managers make informed decisions about how much to charge for their products. Usually, prices positively or negatively affect how many consumers want to buy a product.
The degree to which demand responds to changes in price can change, and when minor price changes have a significant impact on consumer buying behavior, economists call it "elastic demand." In this article, we review the definition of elastic demand, provide the formula, explain how to calculate it and provide examples of when to use elastic demand.
Read more: What Is Elasticity?
What is elastic demand?
Elastic demand is an economic term that describes consumers responding to small changes in an item's price by buying much more or much less of that item. Luxury or non-essential products are more likely to be highly elastic, meaning a small increase in price can often cause many fewer people to purchase that item and a small decrease in price often encourages many more sales. These products are usually very elastic because people can afford to comparison shop for them and frequently choose the least expensive item available that meets their needs.
This measure of the customer base's sensitivity to price changes can help companies make knowledgeable decisions about their prices and adjust other factors, such as marketing, accordingly. For example, if a company that sells watches must raise its prices to accommodate for a change in its supply chain, they might expect that demand to drop. To counteract the effects of elastic demand, they might choose to launch a targeted social media marketing campaign.
Formula for elastic demand
You can use a formula to calculate how responsive demand for a product is likely to be, relative to changes in its price. Here is the formula for elastic demand:
X = ((Q1-Q0) ÷ (Q1+Q0)) ÷ ((P1-P0) ÷ (P1+P0))
When you are using this formula, here are the details you can input for each variable:
Q0: the amount of demand at the beginning of a chosen time period
Q1: the amount of demand at the end of that time period
P0: the price of a product at the beginning of the same period of time
P1: the price of that product at the end of the selected time period
X: the elasticity of demand
This formula divides the percentage of change in demand for a product by the percentage of change in the item's price. You can use the resulting ratio to help make pricing decisions according to your or your company's tolerance for demand fluctuations. The higher value you get for "X," the greater the product's elasticity of demand or the more sensitive your consumers will be to changes in price.
How to calculate elastic demand
Here are some steps you can follow to calculate the elasticity of demand for a given product:
1. Choose your product
For the formula for elastic demand to provide an accurate result, you must use consistent units at the beginning and end of your period of time. Be sure you have a way to isolate the demand for the specific product you are measuring.
For example, if you own a bakery and you are figuring out the elasticity of demand for eclairs, you can make sure that your point-of-sale system includes a separate eclair item. Being as specific as possible about the goods you want to measure can help simplify your calculations when you are done collecting data.
2. Select a period of time
Consider the period of time when you'll be collecting sales data before calculating the elasticity of demand. The time period you choose can impact your results because data can change over different periods of time and at different times of the year.
For example, if you calculate the elasticity of demand for sunscreen over a one-week period in the summer, you are likely to get a different result than if you measure demand for that product over three months in the winter. Decide whether you are interested in the elasticity of demand for a product under certain circumstances, such as a season, or an average over a longer period of time.
3. Measure demand at the beginning
The units you use to measure demand depend on the product you are tracking. It might be hats, sandwiches, cars or even less tangible sales such as customer interactions or help desk tickets. Record the average items sold per your selected unit of time at the beginning of your data tracking period. For example, if you are a baker, you might identify that you initially sold 300 eclairs per week going into your tracking period.
4. Measure demand at the end
Use the same units to measure demand at the end of your chosen time period. For example, if you calculated that you sold those 300 eclairs per week and you wanted to measure the elasticity of demand over one year, you'd determine how many eclairs you sold per week at the end of that year—for instance, 275 eclairs.
5. Record prices at the beginning
Similarly, record your item prices at the beginning of your selected time period. You might, for instance, sell eclairs for $1.50 each at the beginning of your one-year data collection period.
6. Record prices at the end
Over the course of your tracking period, your prices are likely to change. For instance, in the example of the bakery, you might encounter higher prices for materials such as flour and sugar, and your prices might increase to $2.00 each at the end of the year.
7. Calculate the percent of change for demand
Insert the demand at the beginning and end of your chosen period of time into the first portion of the formula, ((Q1-Q0) ÷ (Q1+Q0)). This will give you the percentage change in demand for that time period. If you sold 300 eclairs per week at the beginning of your time period and 275 eclairs per week in the end, it would look like this:
Q0 = 300 eclairs per week
Q1 = 275 eclairs per week
(275-300) ÷ (275+300) = -0.04 or 4%
8. Calculate the percent of change for price
Insert the price at the beginning and end of your time period into the second part of the formula, ((P1-P0) ÷ (P1+P0)). This will give you the percentage change of price over your period of time. If you sold eclairs for $1.50 each at the beginning of your time period and $2.00 at the end, it would look like this:
P0 = $1.50
P1 = $2.00
(2.00-1.50) ÷ (2.00+1.50) = 0.14, or 14%
9. Divide the demand rate of change by price rate of change
You now have a number for your percentage change in demand and one for your percentage change of price. Divide the percent change in demand by the percent change in price. Your result is your elasticity of demand. The higher this number, the more elastic the demand and the more responsive your consumer base will be to changes in price. If your change in demand is -.04 and your price change is 0.14, you would divide -0.04 by 0.14 to get -0.29.
Examples of elastic demand
Calculating the elasticity of demand can be useful in a variety of situations involving pricing. Here are some times when you might need to determine whether a product has elastic demand:
If you use this formula and figure out that demand for your product is highly elastic, you could brainstorm marketing ideas that might counteract higher prices. You could also use your knowledge of price elasticity to advertise lowered prices to drive up demand.
Knowing whether the demand for a product is elastic can also help inform your purchasing decisions. If you know that your consumer base is highly sensitive to changes in price, you might know to seek low-cost materials to keep your prices within a buyer's acceptable range.
Knowing how elastic demand is for products that are typically subject to extra taxes can help determine prices as well. Goods such as alcohol and tobacco are taxed at a relatively higher rate than other products, for example, and retailers may wish to take the additional final cost of these products into consideration when using elasticity to help decide prices.
The demand for some products might be higher at some times and lower at others. Knowing the elasticity of demand for a given product can help you decide the timing of a product release, advertising campaign or temporary sale price. If the demand for an item is highly elastic, you might introduce price changes at times when consumers are likely to buy your product anyway.
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