Curious Cat Investing Dictionary: Price Elasticity of Demand

The price elasticity of demand has to do with what the effect of a price change is on demand. For example, if a store can sell 500 apples at $1 each ($500 total) then:

  • if they would sell 400 at $1.20 ($480 total) then the demand would be elastic - an increase in price would actually decrease total revenue
  • if they would sell 460 at $1.20 ($552 total) then the demand would be inelastic - an increase in price would increase total revenue

An example, that would likely be price inelastic: a gas station with 3 nearby stations. If they try to raise prices much beyond what the others sell gas for people will pass by their station for the others. This is looking at the micro level. Inelastic demand is usually due to ready alternatives - people will just switch to another option rather than pay the higher price.

At the macro level gas prices nationwide, for example, is likely price elastic. Elastic demand is not very sensitive to price changes, consumers don't have ready alternatives and will pay a higher price if they must. If gas prices rise enough there may be some attempts to lower gas use and thus decrease overall demand (but nothing close to offset the increase in prices - as the last few years show vividly - rapidly increasing price with little dampening of demand).

In general price elasticity of demand is also time sensitive (it might be very elastic in the short term - maybe no reasonable supply of alternatives). However, in the long term competitors may be able to provide alternatives that are acceptable and consumers will stitch).

Also many good are price elastic within a certain range and then would become price inelastic (if demand begins to be saturated and everyone that wants the product already has enough and no matter how much more the price was decrease would not increase demand).

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