Price Elasticity of Demand

By the end of this article, you should be able to: define elasticity, compute it, say when a price increase raises versus lowers revenue, and explain how to estimate it when you can't run a clean price A/B test.

Step 1: Meet the problem

A game studio is deciding what to charge for a cosmetic item. Raising the price earns more per sale, but fewer people buy it. Lowering the price sells more copies, but each one earns less. Whether raising the price actually raises total revenue depends entirely on how much quantity falls in response, and that's exactly what elasticity measures.

Step 2: Define it

Elasticity is how sensitive demand is to price: the percentage change in quantity sold for a 1% change in price.

$E = \frac{\%\,\Delta\,\text{quantity}}{\%\,\Delta\,\text{price}}$

It's almost always negative, raising price lowers quantity, so people usually talk about its size, $|E|$, and just remember the direction is down.