The price elasticity of demand is a crucial factor in pricing decisions, litigation, and policymaking. It determines the impact of pricing decisions on sales volumes, profit margins, and behavioural responses. However, estimating demand elasticities accurately is challenging, and there are several approaches to doing so.

In this white paper, Managing Director Daniel Hanson, Consultants Dr. Francis Ostermeijer and Dr. Tuba Toru Delibasi, and Research Officer David Liedig apply the textbook concept of price elasticities of demand to the real world, highlighting the role of demand elasticities in pricing decisions, litigation, and policymaking and the potential costs of getting it wrong. The authors provide insight into the challenges of obtaining credible demand elasticities by:

• Drawing a clear distinction between market, firm, and product price elasticities (see illustration in Figure 2);
• Explaining whether and how to incorporate competitor prices; and
• Shining light on what economists mean by simultaneity bias between demand and supply—an essential consideration to ensure price elasticities are correct.

The authors conclude by outlining actionable solutions economists have devised to estimate elasticities properly and the importance of doing so.