Elastic Demand with Its Formula, Curve, and Examples
When the Amount Bought Is Very Sensitive to Price
Elastic demand is when price or other factors have a big effect on the quantity consumers want to buy. You'll see it most often when consumers respond to price changes. If the price goes down just a little, they'll buy a lot more. If prices rise just a bit, they'll stop buying as much and wait for them to return to normal. Price is one of the five determinants of demand.
If a good or service has elastic demand, it means consumers will do a lot of comparison shopping. They do this when they aren't desperate to have it or they don't need it every day. They'll also comparison shop when there are a lot of other similar choices.
The law of demand guides the relationship between price and the quantity bought. It states that the quantity purchased has an inverse relationship with price. When prices rise, people buy less. The elasticity of demand tells you how much the amount bought decreases when the price increases.
There are two other types of demand elasticity. They also measure how much the quantity purchased changes when the price does.
- Inelastic demand is when the quantity demanded changes less than the price does.
- Unit elastic demand is when the quantity demanded changes by the same percentage that the price does.
The formula for elastic demand is the percentage change in quantity demanded divided by the percentage change in price.
Elastic demand is when the percentage change in the quantity demanded exceeds the percentage change in price. That makes the ratio more than one. For example, say the quantity demanded rose 10% when the price fell 5%. The ratio is 0.10/0.05 = 2.
Perfectly elastic demand is when the quantity demanded skyrockets to infinity when the price drops any amount. That, of course, could not happen in real life. But many commodities approach that situation because they are highly competitive. The price is really the only thing that matters.
For example, two stores sell identical ounces of gold. One sells it for $1,800 an ounce while the other one sells it for $1,799 an ounce. With perfectly elastic demand, no one would buy the more expensive gold. Instead, they all buy gold from the dealer that sells it for less. In the real-life situation of almost perfect elasticity, many people, but not all of them, will choose the cheaper gold over the more expensive one. Some might buy the more expensive gold because they like the shop owner better.
Inelastic demand exists when the quantity demanded rises by a lower percentage than the price drops. For example, the quantity might rise by 2% when the price fell 5%. That ratio is 0.02/0.05 = 0.40, or less than one.
Unit elastic demand is when the quantity demanded changes in the same percentage as the change in price. In that case, the ratio is one. For example, the quantity demanded increased by 5% in response to a price drop of 5%. The ratio is 0.05/0.05 = 1. The price was a negative move while the quantity was a positive move. But there’s no need to include the minus sign since everyone knows that demand moves inversely to price.
Elastic Demand Curve
The demand curve is an easy way to determine if demand is elastic. The quantity demanded will change much more than the price. As a result, the curve will look lower and flatter than the unit elastic curve, which is a diagonal. The more elastic the demand is, the flatter the curve will be. The graph below shows the horizontal line of a perfectly elastic demand curve.
The demand curve is based on the demand schedule. This table describes exactly how many units will be bought at each price.
Price is one of the five factors that determine demand. There's a sixth. This refers to the number of buyers that drives aggregate demand. The important thing to know is that the demand curve only shows how the quantity changes in response to price, "ceteris paribus," or all other things being equal. If one of the other determinants changes, it will shift the entire demand curve. In this case, more or less will be demanded even though the price remains the same.
A good example of elastic demand is housing. There are so many different housing choices. People could live in a townhouse, condo, apartment, or even with friends or family. Because there are so many options, it’s easy for people to not pay more than they want to.
Clothing also has elastic demand. True, people have to wear clothes, but there are many choices of what kind of clothing and how much to spend. When some stores offer sales, other stores have to lower their clothing prices to maintain demand. Small stores that can't offer huge discounts go out of business. During the Great Recession, many clothing stores were replaced by second-hand stores that offered quality used clothing at steeply discounted prices.
The Bottom Line
Under the law of demand, elasticity shows how much a good or service is demanded relative to its movement in price. Key things to remember:
- Elasticity refers to the degree of responsiveness.
- Demand elasticity has three types:
- Elastic – a product’s demanded quantity changes by a greater percentage compared to its percentage change in price.
- Inelastic – the percentage of change in demand is much less than the percentage change in price.
- Unit elastic – percentage change in demand equals that of price.
- A product with an elastic demand gets more sales when its price drops a bit. When its price goes up, it stays longer on the shelves.
- The demand curve shows how quantity demanded responds to price changes. The flatter the curve, the more elastic demand is.