In this article, we’re going to discuss the difference between elastic and inelastic demand. When we talk about inelastic and elastic demand what we’re really talking about is the price elasticity of demand and I just want to give you a quick review. So price elasticity demand is a measure of how responsive that consumers are to a change in the price of a good or service and we calculate it with this formula.
Where we take the percentage change in the quantity demanded of the good or service divided by the percentage change in price and if we calculate that it’ll give us a number that is greater than 1 then we would say that the demand for the good is elastic and that means that customers are very responsive to a change in the price of the good or service. If the price elasticity of demand is equal to 1 we say that it’s unit elastic demand and unit elastic basically means if the price were to go down by one percent then the percent change the quantity demanded would go up by one percent, so one percent divided by one percent is one. However, if this formula gives us a number that is less than 1 then we would say demand for the good is inelastic and that means that customers aren’t that sensitive to a change in the price of the good or service.
So let me give you an example, let’s pretend that you run a grocery store and you’re thinking about increasing the price of milk or a candy bar either one by 10% and you want to know what would happen under each scenario. So let’s take milk first, if you increase the current price of milk by 10% then you predict the quantity demanded would decrease by 2% and so you want to know what the elasticity is. What we do is we take our percent change in price that’s going to go in the denominator and then in the numerator we have the percent change in quantity demanded and remember it doesn’t matter that it’s negative or positive, you ignore whether it’s negative or positive. We know that an increase in price is going to decrease the quantity demanded and so forth. So this is going to give us 0.2 for the milk. The price elasticity of demand is 0.2 and because this is less than 1 we say that demand for milk is inelastic.
So that means that customers are not that price-sensitive with the milk, at least with the price change we’ve talked about here. If you increase the price of milk by 10% it’s not like people say “All right that’s it, I’m not drinking milk anymore.” and the quantity demanded decreases by 50% or 60%. The quantity demanded only goes down by 2% even though you had a 10% price increase. So they’re relatively insensitive to the price of milk they see it as maybe a necessity or something that is very important.
However, if you were to increase the price of the candy bar by 10% then you predict the quantity demanded would decrease by 30% and so and you say what is the elasticity for this candy bar? We’ll take the candy bar now. In our numerator, we’re going to have a percent change in quantity demanded and that is 30% divided by the percent change in the price which is 10%. So 30% divided by 10% is 3 and so because this number is greater than 1 we will say that the demand for the candy bar is elastic.
So that means that when we’re thinking about the candy bar as a good, we could say that if we were to do some kind of price change with this candy bar we should expect our customers to be very responsive. So when the demand for a good is elastic we say that the customers are very responsive to a change in the price. So if you think with the price you increase by 10% the demand for milk went down by two percent and for candy, it went down by thirty percent so that means that people maybe they don’t see a candy bar is as much a necessity as milk, maybe they see it as a luxury or something like that.
Basically, we can look and we can just calculate the price elasticity of demand for each good and so we can just look even if you don’t know what the good is but you see the number, if you know the price elasticity of demand you can say this was milk. You’re just like what is this I don’t know, but seeing the price elasticity of demand is 0.2 you can say that is less than 1 so that means this good is relatively inelastic a price change isn’t going to have as much effect on the quantity demanded of that good so it could be a necessity good. However, if you didn’t know this was a candy bar and you saw the price elasticity demand of 3 or 5 or 10 or whatever something higher than 1 then you will say the demand for that good is elastic so consumers are very responsive to a change in the price of that good, it could be a luxury good.