What elasticity tells you
The price elasticity of demand measures how strongly buyers react to a price change. It is the percentage change in quantity divided by the percentage change in price. Because demand usually falls when price rises, the result is negative; economists often discuss its absolute value. The key threshold is 1: it tells you whether a price increase will raise or lower your revenue.
The midpoint formula
A plain percentage change depends on the direction: going from $10 to $12 is +20%, but going back from $12 to $10 is −16.7%. The midpoint (arc) method avoids that by dividing each change by the average of the two values:
- %ΔQ = (Q2 − Q1) ÷ ((Q1 + Q2) ÷ 2)
- %ΔP = (P2 − P1) ÷ ((P1 + P2) ÷ 2)
- Elasticity = %ΔQ ÷ %ΔP
Worked example
A coffee shop raises the price of a bag of beans from $10 to $12. Monthly sales drop from 1,000 to 850 bags.
- %ΔQ = (850 − 1,000) ÷ 925 = −16.22%.
- %ΔP = (12 − 10) ÷ 11 = +18.18%.
- Elasticity = −16.22 ÷ 18.18 = −0.89: demand is inelastic.
- Revenue goes from $10,000 to $10,200, +2%: the price rise paid off, even before counting the lower cost of selling fewer bags.
Reading the result
| Elasticity (absolute value) | Demand | Effect of a price increase on revenue |
|---|---|---|
| 0 | Perfectly inelastic | Revenue rises in proportion |
| Between 0 and 1 | Inelastic | Revenue rises |
| 1 | Unit elastic | Revenue unchanged |
| Above 1 | Elastic | Revenue falls |
The comparison table shows how the answer changes with the new quantity: had sales fallen to 800 bags, elasticity would be −1.22 and revenue would drop to $9,600.
What makes demand elastic
- Substitutes: the more alternatives, the more elastic. One brand of soda is far more elastic than soft drinks as a whole.
- Share of budget: a price rise on rent or a car matters more than on salt.
- Necessity: gasoline, electricity, tobacco and prescription drugs are inelastic in the short run.
- Time: demand becomes more elastic as people find alternatives, buy a more efficient car or switch suppliers.
Caveats
Two observed points capture more than price: seasonality, a competitor’s promotion or a marketing campaign can also move sales. Test one change at a time, compare similar periods and remember that revenue is not profit. Use the margin calculator to check what each price leaves you after costs.