The price elasticity of demand is a measure of how strongly buyers respond to changes in price. It is the percentage change in quantity demanded that occurs in response to a 1 percent change in price. The demand for a good is called elastic with respect to price if its price elasticity is more than 1; inelastic if its price elasticity is less than 1; and unit elastic if its price elasticity is equal to 1.
Goods such as salt, which occupy only a small share of the typical consumer's budget and have few or no good substitutes, tend to have low price elasticity of demand. Goods like new cars of a particular make and model, which occupy large budget shares and have many attractive substitutes, tend to have high price elasticity of demand. Price elasticity of demand is higher in the long run than in the short run because people often need time to adjust to price changes.
The price elasticity of demand at a point along a demand curve can also be expressed as e = (P/Q) x (1/slope). This formulation tells us that price elasticity declines in absolute terms as we move down a straight-line demand curve.
A cut in price will increase total spending on a good if demand is elastic but reduce it if demand is inelastic. An increase in price will increase total spending on a good if demand is inelastic but reduce it if demand is elastic. Total expenditure on a good reaches a maximum when price elasticity of demand is equal to 1.
Analogous formulas are used to define the elasticity of demand for a good with respect to income and the prices of other goods. In each case, elasticity is the percentage change in quantity demanded divided by the corresponding percentage change in income or price.
Price elasticity of supply is defined as the percentage change in quantity supplied that occurs in response to a 1 percent change in price. The mathematical formula for the price elasticity of supply at any point is (P/Q) x (1/slope), where (1/slope) is the reciprocal of the slope of the supply curve.
The price elasticity of supply of a good depends on how difficult or costly it is to acquire additional units of the inputs involved in producing that good. In general, the more easily additional units of these inputs can be acquired, the higher price elasticity of supply will be. It is easier to expand production of a product if the inputs used to produce that product are similar to inputs used to produce other products, if inputs are relatively mobile, or if an acceptable substitute for existing inputs can be developed. And like the price elasticity of demand, the price elasticity of supply is greater in the long run than in the short run.
