PLUS MoneyWeek Get 4 FREE issues In general, the higher the price of a product the lower the demand for it. However, this is truer in some cases than in others, and the extent to which it is true for each product is referred to as price elasticity.
If a 1% drop in a product’s price produces a 1% increase in demand, the price elasticity of demand is 1.0. If it produces a 2% increase in demand, the price elasticity of demand for the product is 2.0 (the percentage change in demand divided by the percentage change in price). Most consumer goods and services have a price elasticity between 0.5 and 1.5, The closer to zero, the more price ‘inelastic’ the demand is said to be.
Demand for staple foods such as salt, or for addictive goods such as cigarettes and alcohol – which people always need or want regardless of price increases – is inelastic. This, of course, is why they are such great tax revenue raisers. Demand for luxury goods or specialist foods on the other hand tends to be fairly price elastic as buying them can easily be put off or cancelled, so demand falls as the price rises.
