Knowing that demand falls when price rises is useful, but it is not enough. Businesses and governments need to know how much demand falls. That is what elasticity measures.
Price elasticity of demand (PED) quantifies how sensitive consumers are to price changes. If a 10% price increase causes a 20% drop in quantity demanded, PED is 2.0 — demand is elastic. If the same price increase only reduces quantity by 5%, PED is 0.5 — demand is inelastic. This distinction has enormous practical consequences: when demand is elastic, raising prices actually decreases total revenue. When demand is inelastic, raising prices increases revenue.
What determines elasticity? The availability of substitutes is the most important factor. Gasoline has few substitutes, so its demand is inelastic. A specific brand of cereal has many substitutes, so its demand is elastic. Time horizon matters too — demand becomes more elastic over time as consumers find alternatives.
Price elasticity of supply works similarly. Goods that are easy to produce more of quickly (like digital products) have elastic supply. Goods that require years of investment (like housing) have inelastic supply.
You will also study income elasticity — which tells you whether a good is normal or inferior — and cross-price elasticity — which reveals whether goods are substitutes or complements. These tools are essential for understanding how markets respond to shocks, how tax burdens are divided between buyers and sellers, and how firms set prices strategically.
Every concept includes interactive calculations so you can see how changing one variable ripples through the system.