Elasticity of Demand

  • The elasticity of demand shows the reaction of one variable with respect to the change in other variables on which it is dependent. Thus elasticity is an index of reaction. In economics, elasticity refers to a ratio of the relative changes in two quantities. It measures responsiveness or sensitiveness of one variable due to the change in another variable.
  • The elasticity of demand is defined as the responsiveness or sensitiveness of demand to given change in price or non-price determinant of a commodity.



Types of Demands Based on Elasticity:

Inelastic Demand:

  • When consumers buy about the same amount of commodity whether the price drops or falls, then the demand is called inelastic demand. If the commodity is the necessity of the life of the consumer, the consumer purchase the commodity irrespective of the cost.
  • For example demand for petrol for a cab driver is inelastic. He has to buy the petrol irrespective of the higher price because he is earning his living by driving a cab. In turn, when the price of the petrol drops he doesn’t by petrol more than his requirement.
  • Elasticity quotient is less than one.
  • The demand curve is steep.
  • Price and total revenue moves in the same direction.

Elastic Demand:

  • When the price or other factors have a big effect on the quantity of the commodity consumers want to buy., then the demand is called elastic demand. If the price of the commodity goes down just a little, the consumer buys a lot more. If prices of commodity rise just a bit, they stop buying as much and wait for the prices to return to normal.
  • For example demand for luxury and comfort good.
  • In presence of elastic demand, consumers do a lot of comparison shopping.
  • Elasticity quotient is more than one.
  • The demand curve is shallow.
  • Price and total revenue moves in the opposite direction.

Unitary Demand:

  • When the quantity demanded changes the same rate as the price, then the demand is called unitary demand or unit demand.
  • Elasticity quotient is one.
  • In practice, there is no product that has a unitary elasticity of demand.


Types Of Elasticity of Demand:

  • In economics, we consider following five types of elasticity demands. viz. price elasticity, income elasticity, cross elasticity, promotional elasticity and substitution elasticity.


Price Elasticity:

  • It explains the responsiveness of the demand for a product to change in its price.
  • Elasticity quotient of price or coefficient of price elasticity is defined as the ratio of the percentage change in the quantity of the commodity demanded the corresponding change in the price of the commodity. Mathematically

Elasticity of Demand 06

  • If demand rises by 60% by fall in price by 20%, then

Elasticity of Demand 08

  • In General,

Elasticity of Demand 09

Where, D = Original demand, ΔD = Change in demand

P = Original price, ΔP = Change in price.

  • Based on the numeric values of elasticity quotient for price or coefficient of price elasticity, the price elasticity is classified into three types.

Perfectly Elastic Demand:

  • In this case, a very small change in price leads to an infinite change in demand. The demand curve is horizontal i.e. parallel to the x-axis.
  • Elasticity quotient is infinity (∞).

Elasticity of Demand 01

Perfectly Inelastic Demand:

  • In this case any change in the price of the commodity, the quantity demanded remains perfectly constant.
  • Elasticity quotient is zero (0).
  • For example demand for petrol for a car owner is inelastic. He has to buy the petrol irrespective of the higher price because commuting by car is his necessity. In turn, when the price of the petrol drops he doesn’t by petrol more than his requirement.
  • If the price is too high corrective action may be taken by him like to live closer to the workplace, buying more fuel efficient car, carpooling, Use of an alternate mode of transport, etc.

Elasticity of Demand 02



Relatively Elastic Demand:

  • In this case, for the small change in the price of a commodity leads to a proportional change in the quantity demanded.
  • Elasticity quotient is greater than 1.

Elasticity of Demand 03

Relatively Inelastic Demand:

  • In this case, a huge change in price leads to less than proportional change in demand.
  • Elasticity quotient is less than 1.

Elasticity of Demand 04

Unitary Elastic Demand:

  • In this case, there is a proportionate change in price which leads to an equal proportional change in demand.
  • Elasticity quotient is equal to 1.

Elasticity of Demand 05



Determinants of Price Elasticity of Demand:

Nature of Commodity: 

  • The commodities or goods can be categorized as luxury, convenience, necessary goods. The demand for the necessities (food and clothing) is inelastic as their need cannot be postponed.
  • The demand for the comfort or convenience goods (e.g. TV, fridge) is elastic. The change in their price causes a change in the demand.
  • While the demand for luxury goods like diamonds, gems, etc. is highly elastic because a small change in its price the demand changes significantly. But, however, the demand for the luxurious goods is said to be inelastic, because consumers are ready to buy these commodities even at a high price, due to their social appeal.

Existence of Substitutes: 

  • The substitutes are the goods which can be used in place of one another. Thus the commodity and its substitutes are economically interchangeable. The goods like tea and coffee which have close substitutes are said to have elastic demand because the consumer can switch between the two.
  • Toothpaste, soaps have many substitutes hence the demand for them is elastic. Onion, ginger, garlic, and salt have no substitutes, hence their demand is inelastic. People tend to buy them even at higher prices.


Several (Multiple) Uses of Commodity: 

  • Single-use goods are those which can be used for only one purpose. (examples: fertilizers, seeds, pesticides, eatables, etc.). In such case, the change in the price will affect the demand for commodity only in that use, and thus the demand for that commodity is said to be inelastic.
  • Multiple-use goods are those which can be used for more than one purpose. (examples: electricity, coal, iron, steel, etc.). In this case, the change in their price will affect the demand for these commodities in its many uses. Thus, the demand for such products is said to be elastic.

Durability and Repairability of Commodity:

  • Durable goods are those goods which can be used for long period of time (example: furniture, utensils, etxc.). The demand for such goods is elastic.
  • Repairable goods are those goods which can be repaired easily hence such goods can be used for long period of time (examples: TV, Mixers, Washing machine). The demand for such goods is elastic.
  • Perishable goods are those goods which degrade and become useless after some time. (examples: vegetables, milk, fruits, etc.) The demand for such goods is inelastic.

Level of Income of Consumer:

  • For high-income consumers, the demand is said to be less elastic as the rise or fall in the price will not have much effect on the demand for the product.
  • For low-income consumers, the demand is said to be elastic and rise and fall in the price have a significant effect on the quantity demanded.

Postponing the Use of Commodity:

  • If the demand for a particular product cannot be postponed then, the demand is said to be inelastic.
  • The basic necessities like food, clothing cannot be postponed. On the other hand, the items whose demand can be postponed. Hence these demands are inelastic. The demands which can be postponed are elastic demands. (example: furniture, TV, etc.). Such demands can be postponed until the time its prices fall.

Range of Prices or Proportion of Expenditure on a Commodity:

  • Goods like imported cars, high-end mobiles, refrigerators, LED TVs are costly in nature. While goods like pins, matchbox, pencils are low priced. In both the cases, a small change in price does not have an effect on the demand. Thus demands for such products is inelastic.
  • For moderately or normally cost goods the demand is elastic.


Habits:

  • When people are habituated to use of the commodities (examples: tobacco, cigarette, alcoholic beverages), they do not care for price changes over a certain range. Thus the demand is inelastic.
  • If the people are not habituated, then they go for a substitute and the demand becomes elastic.

Period of Time:

  • In short interval of time the consumptions habits, traditions, customs do not change significantly. The demands for such commodities are inelastic. For long period of time, these demands tend to be elastic.

Knowledge of Consumer:

  • For ignorant consumer demand would be inelastic while for the knowledgable consumer the demand is elastic.

Existence of Complementary Goods:

  • The goods or services whose demands are so interlinked that an increase in the price of one of the products results in a fall in the demand of the other product, such goods and services are called complementary of each other. (examples: pen and ink, petrol and car, shoes and socks, etc.). In such cases demand tend to be inelastic. If a good has no complement, its demand is elastic.

Peak and Off-peak Demand:

  • The demand is price inelastic at peak times and more elastic at off-peak times – this is particularly the case for transport services. Example price of movie tickets is more or advertising rates are more at a prime time while they are less at a slack time. In prime slots people are ready to pay a higher price, Thus the demand is inelastic at peak hours. for other time slots, it is elastic.


Frequency of Purchase:

  • If the frequency of purchase is high (generally necessities) then the demand tends to be inelastic. If the frequency of purchase is low, the demand is elastic.

Measurement of Price Elasticity of Demand:

Total Expenditure Method:

  • In this method, total expenditure (price outlay) before and after variation in price is compared. The value of the coefficient of elasticity is calculated by dividing total consumption (price outlay) at a price by total consumption (price outlay) at a previous price.
Price (Rs.) Quantity Demanded Price Outlay (Rs.)

= Price x Demand

Elasticity of demand
5.00 30 150.00 e>1
4.00 50 200.00 e>1
3.00 100 300.00 e>1
4.00 150 600.00 e=1
6.00 100 600.00 e=1
4.00 150 600.00 e<1
3.00 180 540.00 e<1
4.00 120 480.00
  • Observations:
    • When the new outlay is greater than the original outlay, then coefficient of elasticity of demand E > 1.
    • When the new outlay is less than the original outlay, then coefficient of elasticity of demand E< 1.
    • When the new outlay is equal to the original outlay, then coefficient of elasticity of demand E = 1.
    • When total expenditure increases with the fall in price and decreases with the rise in price, then the price elasticity of demand is greater than 1.
    • When total expenditure decreases with the fall in price and increases with the rise in price, then the price elasticity of demand is less than 1.
    • When total expenditure remains the same irrespective of the rise or fall in price, then the price elasticity of demand is equal to 1.
  • Graphical Representation:

Elasticity of Demand 10

Point Method:

  • Professor Marshall advocated this method. Point elasticity of demand refers to the price elasticity of demand (Ed) at any point of the demand curve and it is different at different points on a demand curve. The quantities D = Original demand, ΔD = Change in demand, P = Original price, and ΔP = Change in price at a point are found from demand curve. The price elasticity of demand is calculated using following formula.

Elasticity of Demand 09

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  • The point P is located at which unitary elastic demand exists such that value of elasticity coefficient is 1. The curve if it is linear is allowed to cut x-axis (say at N) and y-axis (say at M). Then point P divides segment MN into two parts upper segment PM and lower segment PN. The ratio of the length of lower segment PN to the length of upper segment PM gives the coefficient of price elasticity of demand.
  • If the demand curve is not linear, we draw a tangent to the curve too cut x-axis (say at N) and y-axis (say at M). Then point P divides segment MN into two parts upper segment PM and lower segment PN. The ratio of the length of lower segment PN to the length of upper segment PM gives the coefficient of price elasticity of demand.

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  • It is to be noted that in this method the demand function is continuous and hence marginal changes can be measured. i.e. E is measured only when changes in price and quantity demanded are small.


Arc Method:

  • This method is used to find the elasticity of demand E when a large change in the price and quantity demanded. Elasticity obtained by this method is called as average elasticity of demand.

Elasticity of Demand 13

  • Two points on the curve are marked. The values of quantity demanded and the corresponding price at these two points is noted. The elasticity of demand is found by following formula.

Elasticity of Demand 14

 

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