Price Elasticity of Demand
Definition of 'Price Elasticity of Demand'
Price Elasticity (which usually refers to the Price Elasticity of Demand) describes how responsive a good is to fluctuations in its price, and that responsiveness is measured by consumer demand. Price elasticity is expressed as the percent change in quantity demanded, divided by the percent change in price. If the price elasticity equals zero, demand is considered perfectly inelastic; if it equals less than one, it is inelastic; if it equals one, it is elastic; and, finally, if it is greater than one, it is considered perfectly elastic.
TheStreet Explains ‘Price Elasticity of Demand’
Elasticity is easy to illustrate. Take, for instance, an incredibly soft, woolen sweater sold by ACME Outfitters. At the beginning of the winter, it retails for $99.00, but after a month, ACME has only sold 40 of them and needs to start moving some inventory pronto—so it reduces the price to $79.00. Suddenly, it sells 400 sweaters the following month. That small price change and extraordinary consumer response means that product is thought to be “elastic.” Or, to apply the formula, a 900% difference in units sold and a 20% difference in price means that the elasticity of demand would be 45—or perfectly elastic. On the other hand, if ACME sold only 40 sweaters that second month (equal to the first month’s sales) after it reduced its price, that product is thought to be not susceptible at all to changes in price, or perfectly inelastic.
Elasticity is a vital concept for businesses of all stripes. After they price their goods for sale, they often must reassess those prices if their goods are not performing as expected or if they wish (as many do) to respond to seasonal sales or tax holidays that bring out consumers in droves. Of course, there isn’t just one retailer that sells sweaters (to take the above example), so businesses must also factor into their pricing comparable products, which generally make demand more elastic in the marketplace.
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