Price elasticity of demand measures how much volume moves when price moves. Enter what you charged and sold before a price change, and what you charged and sold after, and the calculator returns the elasticity along with what happened to revenue.
The optional section is the one that changes decisions. Add your variable cost per unit and it shows the effect on gross profit, which frequently points in the opposite direction to revenue. A price cut that lifts revenue by 9% can cut profit by 17%, and the revenue line will never tell you.
What price elasticity actually measures
Elasticity is the percentage change in quantity divided by the percentage change in price.
It is a sensitivity measure. An elasticity of −2 means a 1% price rise costs you 2% of volume. An elasticity of −0.3 means the same price rise costs you only 0.3% of volume. The first business has very little pricing power. The second has a great deal.
The number is almost always negative, because raising price reduces demand. Most people drop the sign in conversation and talk about elasticity of 2 or 0.3, which is fine as long as everyone knows what is meant. What matters is whether the absolute value sits above or below 1.
The midpoint formula
Elasticity = [(Q₁ − Q₀) ÷ ((Q₁ + Q₀) ÷ 2)] ÷ [(P₁ − P₀) ÷ ((P₁ + P₀) ÷ 2)]
The midpoint method divides each change by the average of the start and end values rather than by the starting value alone. This matters more than it sounds.
Using simple percentage changes, a move from $800 to $700 is a 12.5% cut, while a move from $700 to $800 is a 14.3% rise. The same price change produces two different elasticities depending on which direction you happen to measure it in. The midpoint formula removes that asymmetry: measure from $800 to $700 or from $700 to $800 and you get the identical answer. That is why economists use it and why the calculator does too.
A worked example
An electronics retailer sells 200 televisions a month at $800. Cutting the price to $700 lifts sales to 250.
Change in quantity = 50 ÷ 225 = 0.2222
Change in price = −100 ÷ 750 = −0.1333
Elasticity = 0.2222 ÷ −0.1333 = −1.67
Demand is elastic, so the price cut increased revenue. Revenue rose from $160,000 to $175,000, up 9.4%.
Now add the cost of a television, say $500.
Gross profit before = ($800 − $500) × 200 = $60,000
Gross profit after = ($700 − $500) × 250 = $50,000
Gross profit fell 16.7% on the same decision that lifted revenue 9.4%. The retailer sold 50 more units, handled 50 more deliveries, took 50 more support calls, and finished $10,000 worse off.
This is the single most important thing to understand about elasticity. Revenue-maximising and profit-maximising prices are different, and the profit-maximising price is always higher.
Reading the number
Elasticity | Name | What a price cut does to revenue |
|---|---|---|
0 | Perfectly inelastic | Falls in direct proportion to the price |
Between 0 and −1 | Inelastic | Falls |
−1 | Unitary | No change |
Below −1 | Elastic | Rises |
Approaching −∞ | Perfectly elastic | Any price rise removes all demand |
Two rules follow, and they are the whole practical content of the concept.
If demand is inelastic, raise your price. Volume moves less than price does, so revenue rises and, because you are also selling fewer units, costs fall. Both directions help.
If demand is elastic, a price rise costs you revenue. Whether it costs you profit depends on your margin, which is exactly why the calculator asks for unit cost.
The number to watch for is −1. That is where revenue peaks. Above it in absolute terms and you are in territory where discounting can grow the top line. Below it and every discount is money given away.
What makes demand elastic
Substitutes. The more alternatives, the more elastic. This is the largest single determinant, and it explains why commodity products have almost no pricing power and differentiated ones have a great deal.
Necessity. Things people cannot go without absorb price rises. Things they can defer do not.
Share of income or budget. A 10% rise on something trivial goes unnoticed. The same rise on a major purchase triggers shopping around.
Time. Demand is far more elastic over long periods than short ones, because customers eventually find alternatives, renegotiate, or change behaviour. A price rise that looks safe after one quarter can look very different after four.
Switching costs. Contracts, integrations, learned habits, and accumulated data all suppress elasticity. Most of what software companies call moats are switching costs, and their commercial expression is inelastic demand.
Who pays. Demand is markedly less elastic when the buyer is not spending their own money, which is much of why business purchasing behaves differently from consumer purchasing.
Where elasticity misleads
One observation is not a demand curve. Two price points give you the elasticity between those two points, on that occasion, for that segment. Elasticity is not constant along a demand curve, and it is typically higher at higher prices.
Correlation is not causation. Sales rose after you cut prices. Sales also rose because of the season, a competitor's stockout, and a campaign that happened to run. Unless you controlled for those, you measured the market rather than your price.
Short-run readings flatter price rises. Customers absorb an increase before they have found an alternative. Measuring elasticity four weeks after a rise systematically understates it.
It ignores brand damage. A price rise that customers judge to be unfair can suppress demand far beyond what any elasticity estimate predicts, and the effect persists after the price is reversed.
Averages hide segments. Your most loyal customers and your most price-driven customers have completely different elasticities. A single number averages them and tells you to do something that is wrong for both.
How operators actually measure it
Test on a slice, not on everyone. A price test in one region, one channel, or one cohort gives you a reading without risking the whole base.
Hold everything else still. Same season, same promotion, same audience. The value of an elasticity estimate is entirely determined by how much else was moving.
Measure over a long enough window. Long enough for customers to have found alternatives if they were going to.
Always compute the profit effect too. The calculator does it above. Deciding on revenue alone is the classic error, and it is expensive.
Segment before you conclude. If one group is elastic and another is not, the answer is not one price. It is two.
Remember that elasticity is something you can change. Differentiation, switching costs, and brand all reduce it, and reducing it is worth more than any single price decision.
Further reading from Revenue Memo
FAQs
How do I calculate price elasticity of demand?
Divide the percentage change in quantity by the percentage change in price, using the midpoint method so that each change is measured against the average of the before and after values. Selling 200 units at $800 and 250 units at $700 gives an elasticity of −1.67.
Why is the midpoint formula used?
Because ordinary percentage changes give different answers depending on which direction you measure in. A cut from $800 to $700 is 12.5%, while the reverse rise is 14.3%. The midpoint method divides by the average of both values, so the elasticity is the same either way.
What does an elasticity of −1.67 mean?
Demand is elastic. A one percent price rise costs you 1.67% of volume, so raising price reduces revenue and cutting price increases it. Whether cutting price increases profit depends entirely on your margin.
Is elastic or inelastic demand better?
Inelastic, from the seller's point of view. It means customers keep buying when you raise the price, which is the definition of pricing power. Elastic demand means the market has alternatives and will use them.
Why is price elasticity of demand negative?
Because price and quantity move in opposite directions. Raising the price reduces demand, so the ratio of the two changes is negative. Most people quote the absolute value and drop the sign.
Does maximising revenue also maximise profit?
No, and this catches people out constantly. Revenue peaks where elasticity equals −1. Profit peaks at a higher price, because selling fewer units also costs less to fulfil. A price cut that raises revenue can reduce profit, which the calculator above will show you if you enter your unit cost.
What is cross price elasticity of demand?
It measures how demand for one product responds to a price change in another. A positive figure means the products are substitutes, so one getting more expensive drives demand to the other. A negative figure means they are complements, bought together.