What Is Price Elasticity of Demand?
Price elasticity of demand measures how sensitive your customers are to price changes. It determines whether raising your prices will increase or decrease your total revenue.
Key Takeaways
- Price elasticity = % change in quantity demanded ÷ % change in price
- Elastic demand (>1): price increases reduce total revenue. Inelastic demand (<1): price increases grow total revenue
- Most consumer goods are elastic; niche B2B software, utilities, and must-have products tend to be inelastic
- Test price elasticity before a global price change — use cohorts, geographies, or plan tiers
The formula
Price elasticity of demand (PED) = percentage change in quantity demanded ÷ percentage change in price. If you raise the price of your product by 10% and demand falls by 15%, your PED is −1.5 (the negative sign reflects the inverse relationship between price and demand, which is standard — most analysts use the absolute value). A PED of 1.5 means demand is elastic: demand changes proportionally more than the price change.
Elastic vs inelastic demand
If PED > 1, demand is elastic: customers are price-sensitive, and a price increase will reduce total revenue (you lose more volume than you gain in per-unit price). If PED < 1, demand is inelastic: customers are not very price-sensitive, and a price increase will increase total revenue. If PED = 1, demand is unit elastic: price changes have no net effect on total revenue. The strategic implication is straightforward: if your product has inelastic demand, raising prices increases revenue with minimal volume loss. If demand is elastic, discounting might increase revenue — but also trains customers to wait for sales.
What drives price sensitivity
Key drivers of inelastic demand: few or no substitutes available, the product is a small percentage of the buyer's total spend, it is a necessity rather than a luxury, high switching costs, and strong brand loyalty. Drivers of elastic demand: many alternatives available, commodity-like product, large share of buyer's budget, low switching costs, and price-comparison behaviour. Understanding these drivers lets you position to reduce elasticity — through differentiation, switching costs, and brand investment.
How to measure it for your business
Direct experimentation is the most reliable method: test a price change on a cohort of customers (a geographic region, a pricing plan, a new customer segment) and measure the demand response. A/B price testing in SaaS products is the cleanest form of this. Surveys and conjoint analysis can estimate willingness-to-pay before a price change. Van Westendorp price sensitivity meter is a simple survey framework that identifies acceptable price ranges.