Elasticity of Demand

The quantity demanded of a good or service responds to changes in its own price, changes in the price of other goods or services, and changes in consumer income. Demand elasticities measure the responsiveness of the quantity demanded to changes in these factors. The own-price elasticity of demand equals the percentage decrease in quantity demanded, divided by the percentage increase in price of a given product or service. For example, the own-price elasticity of demand for hospital admissions has been estimated to be between –0.1 and –0.2. A 1% increase in the price of a hospital stay reduces demand for hospital admissions by 0.1%. If a 1% increase in the price of a product or service leads to more than a 1% decrease in quantity demanded, then demand is said to be price elastic. Conversely, if the absolute value of the own-price elasticity of demand is less than 1, then demand for the product or service is said to be price inelastic.

The cross-price elasticity of demand is equal to the percentage change in quantity demanded divided by the percentage change in price of another good or service. If this fraction is negative, then the two goods or services are complements. If the cross-price elasticity of demand is positive, then the two goods or services are complements. The income elasticity of demand is equal to the percentage change in quantity demanded, divided by the percentage change in consumer income.