Price Elasticity of Demand

Measuring sensitivity

Price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price. If a 10% price rise cuts sales by 20%, demand is elastic (the ratio exceeds one in size); if the same price rise cuts sales by only 3%, demand is inelastic. The sign is almost always negative because price and quantity move in opposite directions, so economists usually focus on the magnitude.

Elasticity hinges on how easily buyers can do without the good or find substitutes, and on how big a share of income it eats up.

Inelastic versus elastic in India

Necessities and addictive goods tend to be inelastic. Studies of tobacco in India have found cigarettes to be the least price-elastic of tobacco products, with estimated own-price elasticities below one, and poorer consumers generally more responsive than richer ones. That is precisely why the government can lever heavy GST and cess on cigarettes to raise revenue without collapsing consumption.

Discretionary and easily substituted goods are more elastic: a sharp price hike on a particular brand of biscuits, a non-essential gadget, or one airline's fares pushes buyers to rivals or to delay purchase.

Why it drives pricing and policy

Elasticity is the hinge on which both tax policy and corporate pricing turn. For inelastic goods, raising the price (or tax) lifts total revenue, which is why duties cluster on fuel, tobacco and liquor. For elastic goods, a price cut can raise total revenue by winning enough extra volume.

Companies estimate elasticity before changing prices, and policymakers weigh it when designing GST slabs or fuel taxes. Understanding whether demand for a good is elastic or inelastic is, in effect, understanding how much pricing power a seller, or a tax authority, really has.