If you raise a price, you will probably sell fewer units. The real question is how many fewer, and whether the drop is big or small compared with the price change. Economists answer that with one number, the price elasticity of demand, and you can work it out with a pencil in under a minute.
What price elasticity actually measures
Price elasticity of demand tells you how strongly the quantity people buy reacts when a price moves. In plain terms, it is the percentage change in quantity demanded for each 1% change in price, assuming nothing else changes at the same time.
Because a higher price usually means fewer sales, the number is normally negative. What matters is its size, and the reference point is 1:
- Perfectly inelastic (0): quantity does not move at all, whatever the price.
- Inelastic (between 0 and -1): quantity changes less, in percentage terms, than the price.
- Unit elastic (exactly -1): both change by the same percentage.
- Elastic (below -1): quantity changes more than the price.
- Perfectly elastic (minus infinity): the tiniest price increase makes all demand vanish.
The idea was formally defined by the economist Alfred Marshall in his book Principles of Economics in 1890.
The formula, step by step
The quickest version divides one percentage change by the other: elasticity = % change in quantity ÷ % change in price.
The catch is that a percentage change depends on where you start. To get the same answer whichever direction you calculate, use the midpoint method (also called arc elasticity), which measures both changes against their averages:
Elasticity = (change in quantity ÷ change in price) × (sum of the two prices ÷ sum of the two quantities)
Translated into plain language: how many units you lose per dollar of price increase, scaled by the typical price and the typical quantity over the range you are looking at.
A real example with real numbers
Say a product’s price goes from $10 to $16, and the quantity sold falls from 100 to 80 units.
Simple method, starting from $10: quantity falls by 20 out of 100, which is -20%. Price rises by 6 out of 10, which is +60%. Elasticity = -20 ÷ 60 = about -0.33.
Simple method, starting from $16: now the price drops from $16 to $10 (-37.5%) and quantity climbs from 80 to 100 (+25%). Elasticity = 25 ÷ -37.5 = about -0.67.
Same two price points, two different answers. This is known as the index number problem, and it is exactly why the midpoint method exists.
Midpoint method: the change in quantity is -20 and the change in price is 6, so -20 ÷ 6 = -3.33. The sum of the prices is 10 + 16 = 26, and the sum of the quantities is 100 + 80 = 180. Multiply: -3.33 × (26 ÷ 180) = about -0.48, whichever direction you go.
Every version lands between 0 and -1, so demand is inelastic over this price range: buyers reacted less than the price moved. You can also see it in the money. At $10, 100 units bring in $1,000. At $16, 80 units bring in $1,280. In this example, the higher price lost a fifth of the buyers but still raised total revenue by 28%.
What changes the number
Elasticity is not a fixed property of a product. The main factors that push it up or down are:
- How many close substitutes exist, and how easy they are to switch to
- Whether the item is a necessity or a luxury
- The time horizon, since demand tends to become more elastic over the long run as people find alternatives
- Brand loyalty
- Whether the buyer pays out of their own pocket or someone else covers the bill
Common mistakes to avoid
Assuming a straight demand line has one elasticity. Even when the slope of a linear demand curve stays constant, elasticity changes from one point on the line to the next. A result calculated between $10 and $16 says nothing reliable about what happens between $30 and $40.
Mixing up the direction. As the example shows, the simple percentage method gives -0.33 one way and -0.67 the other. If you compare products or price tests, use the midpoint method every time so your numbers are consistent.
Confusing “big change” with “elastic”. Demand is only called elastic when the value is below -1, meaning quantity moved proportionally more than price. Losing 20 buyers can feel like a lot, but against a 60% price jump it is still inelastic.
Before your next price change, jot down the old and new price and the sales you expect at each, then run the midpoint formula. It takes a minute and tells you far more than the raw drop in units.
