How much ice-cream do you buy over the summer given that it costs one euro per scoop? And how much would you buy if the price increased to 1.20 euros per scoop?
Two scoops or one?
The elasticity of demand measures exactly this: how does the quantity demanded by consumers change in relation to changes in prices. In other words, how much can the seller ‘stretch’ prices (like an elastic band – hence the name) before consumers start buying a different amount, and how much will that amount vary?
Demand is elastic if the quantity demanded by consumers, who are given a price change, varies more than that change in price.
Imagine over the summer if you buy a total of 20 scoops of ice-cream for one euro each. If the price of ice-cream increases to 1.20 euros per scoop and you buy 10 scoops less, then your demand is elastic. The price increased by one-fifth and you cut your shopping by more than one-fifth – in fact by one-half.
Luxury world problem
Demand is usually elastic for goods that do not fulfil basic needs and that we can live without – precisely like ice-cream.
Demand is inelastic if the quantity demanded by consumers given a price change varies less than the price change. In the example above, your demand would be inelastic if you were buying 20 scoops also at 1.20 euros.
Demand is usually inelastic for primary needs such as medicines, which sometimes we need no matter the price.
Useful for businesses
The elasticity of demand is not constant for a given good or consumer, but varies depending on the current price level, quantity demanded, and the price change applied. You might still buy 20 scoops at 1.20 euros, but you might decrease your ice-cream consumption if the price increased to 1.50 euros per scoop.
Why is the elasticity useful? The elasticity of demand provides a lot of information regarding consumers’ buying behaviours in relation to a good. This is useful to companies, as they can predict their customers’ behaviour when changing prices and set optimal prices for their goods.