Demand Elasticity

In economics, the demand elasticity refers to how sensitive the demand for a good is to changes in other economic variables. Demand elasticity is important because it helps firms model the potential change in demand due to changes in price of the good, the effect of changes in prices of other goods and many other important market factors. A firm grasp of demand elasticity helps to guide firms toward more optimal competitive behavior. Elasticities greater than one are called "elastic," elasticities less than one are "inelastic," and elasticities equal to one are "unit elastic."

Demand elasticity is a measure of how much the quantity demanded will change if another factor changes. One example is the price elasticity of demand; this measures how the quantity demanded changes with price. This is important for setting prices so as to maximize profit.

When price elasticity of demand is elastic, the firm should lower prices, since it will result in a big uptick in demand, increasing your total revenue. When price elasticity of demand is inelastic, you should increase prices because there will be only a small decrease in demand, and again, total revenue will increase. When price elasticity of demand is unit elastic, changing the price will not change total revenue, since price and quantity will generally change in lock step with each other.