The Unbending Rule: A Guide to Inelastic Demand
Decoding the Price Elasticity of Demand (PED)
At the heart of understanding demand is a simple question: How sensitive are buyers to a price change? Economists answer this with the Price Elasticity of Demand (PED). It's a calculated number that shows the percentage change in quantity demanded compared to the percentage change in price.
$PED = \frac{\%\ Change\ in\ Quantity\ Demanded}{\%\ Change\ in\ Price}$
To calculate the percentage changes, we use the midpoint method for accuracy. If the price of milk increases from $2.00 to $2.20 and the quantity bought falls from 100 bottles to 95 bottles, the calculation is:
% Change in Quantity = $\frac{95 - 100}{(95+100)/2} = \frac{-5}{97.5} \approx -5.13\%$
% Change in Price = $\frac{2.20 - 2.00}{(2.20+2.00)/2} = \frac{0.20}{2.10} \approx 9.52\%$
$PED = \frac{-5.13\%}{9.52\%} \approx -0.54$
We interpret the absolute value, 0.54, which is < 1. This is inelastic demand.
The resulting PED value falls into clear categories. An elasticity of exactly 1 is called unit elastic. A value greater than 1 (like 1.5 or 3) means demand is elastic—quantity demanded is very responsive to price. Our focus is on the range below 1.
What Makes Demand Inelastic? The Key Factors
Not all products have the same sensitivity to price. Several factors determine whether a good or service will have inelastic demand.
| Factor | Explanation | Real-World Example |
|---|---|---|
| Necessity vs. Luxury | Goods essential for daily life (necessities) have inelastic demand. People will buy them almost regardless of price. Luxuries have elastic demand. | Insulin for a diabetic (necessity, inelastic) vs. a luxury cruise vacation (luxury, elastic). |
| Availability of Substitutes | The fewer close substitutes available, the more inelastic the demand. If you have no good alternative, you pay the higher price. | Gasoline for your car (few short-term substitutes) vs. one brand of orange juice (many substitutes). |
| Time Horizon | Demand is usually more inelastic in the short run. Given more time, consumers can find alternatives or change habits, making demand more elastic. | A sudden spike in electricity prices (inelastic short-run) may lead to buying energy-efficient appliances over years (elastic long-run). |
| Addiction or Habit | Goods that are addictive or part of a strong habit tend to have inelastic demand, as consumers are less sensitive to price changes. | Cigarettes for a smoker or your favorite daily coffee from a specific café. |
| Proportion of Income | Goods that take up a very small portion of your budget (like salt or matches) tend to have inelastic demand because you barely notice the price change. | A 50% increase in the price of a pencil has little effect on how many you buy. |
Inelastic Demand in Action: From Taxes to Tickets
The concept of inelastic demand isn't just theory; it has powerful real-world implications for governments, businesses, and our daily lives.
Government Taxation: Governments often place "sin taxes" on goods like cigarettes, alcohol, and gasoline. Why? Because these goods typically have inelastic demand. If the demand is inelastic, a tax that increases the price will lead to only a small decrease in the quantity sold. This means the government collects significant tax revenue without causing a massive drop in sales. Consumers, having few good alternatives in the short term, end up bearing most of the tax burden.
Business Pricing Power: A company selling a product with inelastic demand has more "pricing power." Think of a pharmaceutical company with a patent on a life-saving drug. Because the drug is a necessity with no substitutes, the company can raise prices significantly, and patients will still buy it. This is why drug pricing is such a sensitive political issue. Conversely, a company selling a product with elastic demand (like soft drinks) must be very careful with price hikes, as consumers will quickly switch to other brands.
Everyday Examples:
- Utilities: Your water and electricity bills. You might grumble when the price goes up, but you're unlikely to stop using lights or water for your home. The demand is highly inelastic.
- Emergency Services: If your car breaks down on the highway, you'll pay what the tow truck company charges. In that moment, you have no alternatives, making demand perfectly inelastic.
- School Supplies: When a teacher assigns a specific, unique textbook for a required course, students have little choice but to buy it, even if the price is high—another example of inelastic demand created by a lack of substitutes.
Important Questions
If demand is inelastic, what happens to total revenue when price increases?
Total revenue (Price x Quantity) increases. This is a crucial relationship. With inelastic demand, the percentage drop in quantity demanded is smaller than the percentage increase in price. So, the higher price effect outweighs the lower quantity effect. For example, if a water company raises prices by 10% and quantity demanded falls by only 2%, the company's total revenue goes up.
Can demand be perfectly inelastic?
Yes, in theory. Perfectly inelastic demand means the quantity demanded does not change at all when the price changes. It is represented by a vertical demand curve on a graph. The PED is exactly 0. Real-world examples are rare but can include absolute necessities for survival in a specific moment, like a life-saving dose of medicine for an individual, or a person's demand for insulin within a certain range.
Is inelastic demand good or bad for consumers?
Generally, it is less favorable for consumers. When demand is inelastic, consumers have less power to "vote with their wallets" by refusing to buy when prices rise. They are more vulnerable to price increases because they need the product and lack good alternatives. This can lead to higher spending on necessities, leaving less money for other goods. However, for very cheap items that take a tiny part of the budget (like salt), inelastic demand is not a major concern.
Footnote
[1] PED (Price Elasticity of Demand): A numerical measure of the responsiveness of the quantity demanded of a good to a change in its price. It is calculated as the percentage change in quantity demanded divided by the percentage change in price.