Demand Elasticity Formula

Updated July 25, 2023

Demand Elasticity Formula (Table of Contents)

• Formula
• Examples

What is the Demand Elasticity Formula?

The term “demand elasticity” refers to a product’s demand change due to changes in other economic factors, primarily consumer income and product price.

In other words, demand elasticity measures the impact of various factors on the demand for the subject product. The two major types of demand elasticity are – 1) Income elasticity of demand and 1) Price elasticity of demand.

The formula for income elasticity of demand can be expressed by dividing the % change in demand (∆D/D) by the % change in real consumer income (∆I/I). The mathematical representation of the formula is as below:

or

where,

• D_i = Initial Demand
• D_f = Final Demand
• I_i = Initial Real Income and
• I_f = Final Real Income

The formula for price elasticity of demand can be expressed by dividing the % change in demand (∆D/D) by the % change in the product price (∆P/P). The mathematical representation of the formula is as below:

or

where,

• D_i = Initial Demand
• D_f = Final Demand
• P_i = Initial Price and
• I_f = Final Price

Examples of Demand Elasticity Formula (With Excel Template)

Let’s take an example to understand the calculation of Demand Elasticity in a better manner.

Demand Elasticity Formula – Example #1

Let us take the example of rice’s per capita consumption to illustrate the concept of income elasticity of demand. In a certain country, the per capita income has increased from $2,000 to $3,000 during the last decade. During the same period, rice’s per capita consumption increased from 60 kg to 63 kg. Calculate the income elasticity of demand in this case.

Solution:

The formula to calculate the % Change in Demand is as below:

% Change in Demand (∆D/D) = [(D_f – D_i)] / [(D_f + D_i) / 2]

• % Change in Demand = [(63 – 60)] / [(63 + 60) / 2]
• % Change in Demand = 4.88%

The formula to calculate the % Change in Income is as below:

% Change in Income (∆I/I) =[(I_f – I_i)] / [(I_f + I_i) / 2]

• % Change in Income = [($3,000 – $2,000)] / [($3,000 + $2,000) / 2]
• % Change in Income = 40.00%

The formula to calculate the Income Elasticity of Demand is as below:

Income Elasticity of Demand = % Change in Demand (∆D/D) / % Change in Income (∆I/I)

• Income Elasticity of Demand = 4.88% / 40.00%
• Income Elasticity of Demand = 0.12

0.12, which indicates the inelastic nature of demand.

Demand Elasticity Formula – Example #2

Let us take the example of a soft drink manufacturing company to illustrate the concept of price elasticity of demand. Last month the company was able to sell 50,000 bottles of soft drinks at $1.50 per bottle. However, in the current month, the company has revised the price to $1.45 per bottle and expects to achieve month-end sales of 60,000. Calculate the price elasticity of demand.

Solution:

The formula to calculate the % Change in Demand is as below:

% Change in Demand (∆D/D) = [(D_f – D_i)] / [(D_f + D_i) / 2]

• % Change in Demand = (60,000 – 50,000) / [(60,000 + 50,000) / 2]
• % Change in Demand = 18.18%

The formula to calculate the % Change in Price is as below:

% Change in Price (∆P/P) = [(P_f – P_i)] / [(P_f + P_i) / 2]

• % Change in Price = [($1.45 – $1.50)] / [($1.45 + $1.50) / 2]
• % Change in Price = -3.39%

The formula to calculate the Price Elasticity of Demand is as below:

Price Elasticity of Demand = % Change in Demand (∆D/D) / % Change in Price (∆P/P)

• Price Elasticity of Demand = 18.18% / (-3.39%)
• Price Elasticity of Demand = -5.36

-5.36, which indicates the elastic nature of demand

Explanation

By using the following steps, we can derive the income elasticity of the demand formula:

Step 1: Firstly, figure out the real income at the start of a period and the demand at that income level. Ii and Di, respectively, denote them.

Step 2: Next, figure out the real income at the end of the period and the demand at that income level. They are denoted by I_f and D_f, respectively.

Step 3: Next, compute the % change in demand by dividing the difference between the initial and final quantity by the average of the initial and final quantity.

% Change in Demand = [(D_f – D_i)] / [(D_f + D_i) / 2]

Step 4: Next, compute the % change in real income by dividing the difference between the initial and final income by the average of the initial and final income.

% Change in Income = [(I_f – I_i)] / [(I_f + I_i) / 2]

Step 5: Finally, we can derive the income elasticity of demand formula by dividing the % change in demand (step 3) by the % change in income (step 4) as shown below.

Income Elasticity of Demand = [(D_f – D_i) / (D_f + D_i)] / [(I_f – I_i) / (I_f + I_i)]

Similarly, the formula for price elasticity of demand can be derived by replacing the real income with the product price.

Price Elasticity of Demand = [(D_f – D_i) / (D_f + D_i)] / [(P_f – P_i) / (P_f + P_i)]

Relevance and Use of Demand Elasticity Formula

It is important to understand the concept of demand elasticity as it can be used to build various business strategies such as discount offers and luxurious substitute products in case of price elasticity of demand.

Based on price elasticity, businesses decide on the pricing policy for pursuing different target markets. On the other hand, income elasticity of demand can be used to categorize goods into two broad categories – normal and inferior goods.