What is price elasticity of demand?

Price elasticity of demand shows how sensitive buyers are to price. It equals the percentage change in quantity demanded divided by the percentage change in price, and is usually negative because demand falls as price rises. It tells a seller whether a price change will raise or lower revenue.

How it works

If the absolute value is above 1, demand is elastic: quantity falls by a larger percentage than price rises, so total revenue drops. If it is below 1, demand is inelastic: quantity falls by less, so revenue rises. At exactly 1, revenue stays the same.

Elasticity is higher when good substitutes exist, when the purchase is a large share of the budget and when buyers have time to adapt. It is lower for necessities and for goods with no close alternative. The value is rarely constant. Elasticity tends to be higher at high prices and lower at low ones, so a measurement taken in one range should not be assumed to hold in another. Testing small price changes and observing the response is the practical way to estimate it.

Example

Say a subscription costs 10 and has 1,000 subscribers, for revenue of 10,000. The price rises to 11, a 10% increase, and subscribers drop to 920, an 8% fall. The elasticity is -8 / 10 = -0.8, which is inelastic, and revenue rises to 10,120. If subscribers had dropped to 850, the elasticity would be -1.5 and revenue would fall to 9,350. Illustrative numbers only.

In a game economy, designers test how many players still buy a bundle after its price goes up, to find the price that brings in the most revenue.

How to model it in Machinations

Use a Register for price and a Source for buyers whose rate is driven by a State connection from price, with a slope equal to the elasticity. Use another Register to compute revenue as price times buyers. Make price a Lever, Play, and chart revenue to find its peak.