Introduction to Elasticity of Demand



Learning Contents:

·         Concept of Demand and Elasticity of Demand

·         Various Concepts of Elasticity of Demand

·         Concept of Elastic and  Inelastic Demand

 

Concept of Demand and Elasticity of Demand

The Law of demand explains that, keeping other factors constant, demand for a commodity is inversely related to its price. In other words, if the price for a commodity rises, the quantity demand decreases. On the other hand, if price falls, quantity demand increases. Therefore, the concept of demand focuses on the direction of change i.e. how demand changes due to a change in price. In simple words, it explains that demand either increases or decreases as a result of a change in price but it overlooks an important aspect i.e. degree of change in demand i.e. How much or to what extent demand changes due to change in price? The degree of change is explained by the elasticity of demand. Therefore, the elasticity of demand measures the degree of change in demand as a result of a change in the price of a commodity. Let’s understand  simply a difference between demand and elasticity of demand with the help of an example, when we say that “the demand for an edible oil increases due to fall in its price”, it will be called a concept of demand whereas, saying that “the demand for an edible oil increases by 20% as a result of 10% fall in its price”, it will be called elasticity of demand.

Various Concepts of Elasticity of Demand:

It is not only the price that changes the demand for a commodity. But, besides price, there are also some other factors such as the price of related goods, income, taste and preferences, expectations about future price, etc. that cause a change in the demand for a commodity. Therefore, the concept of elasticity of demand can be defined as a degree of change in demand for a commodity as a result of a change in its own price of the commodity, changes in the price of related goods i.e.substitute goods and complementary goods, change in income of the consumer, etc. Therefore, the concept of elasticity of demand can be studied briefly with respect to the following major categories:

1.      Price Elasticity of Demand

2.      Cross Elasticity of Demand

3.      Income Elasticity of Demand


1.      Price Elasticity of Demand

      When the demand for a commodity change as a result of the only change in its price, it is referred to as, price elasticity of demand. In other words, price elasticity of demand measures the percentage change in quantity demanded a commodity as a result of percentage change in its own price. 

2. Cross Elasticity of Demand

     When the demand for a commodity change as a result of the change in the price of related goods, which might be a substitute good or a complementary good is referred to as, cross elasticity of demand. In other words, Cross elasticity of demand measures the percentage change in quantity demanded a commodity as a result of percentage change in the price of related goods.

3.  Income Elasticity of Demand

     When the demand for a commodity change as a result of the change in the income of the consumer is referred to as, income elasticity of demand. In other words, Income elasticity of demand measures the percentage change in quantity demanded a commodity as a result of percentage change in income of the consumer.



Concept of Elastic Demand and Inelastic Demand

As we know that consumers are sensitive to the price of the commodity. Consumers buy more when prices are low and buy less when prices are high.  Hence, Elasticity explains to what extent consumers would change their purchase decision based on price change. Demand would be elastic when demand for a commodity is very much affected as a result of its price change. For e.g. Demand for Substitute goods are elastic as consumers can easily switch to substitute goods whose price has not been changed. On the other hand, Demand would be inelastic when price change doesn’t affect the demand for a commodity. For e.g. Demand for necessary goods such as sugar, salt, fuel, etc. is less affected by the change in their price.

Elastic Demand

Elastic demand is when the percentage change in quantity demand for a commodity is greater than the percentage change in the price for a commodity. In other words, it is when the change in quantity demand is greater than the change in price. An example of products with an elastic demand is consumer durables such as Television, Refrigerators, washing machines, etc. Consumers do not purchase these goods frequently and also postpone their purchase decision if the price rises. Substitute goods also have an elastic demand as consumers can easily switch to other good options if the price rises. The formula used to calculate the elasticity is given below:











Here,

Ed = Price Elasticity of Demand

Q= Initial demand; Q1= New demand;

P= Initial price; P1 = New Price;

ΔQ= Change in quantity demand; ΔP= Change in price.

 

Interpreting Elastic demand

If the formula creates an absolute value that comes out to be more than 1, there will be an elastic demand.

Elastic Demand Example

Supposing the price of a good decreases from ₹ 4 to ₹ 2, (50%) the quantity demand increases from 1 unit to 4 units, (300%). What will be the elasticity of demand?

Using the Elasticity of demand formula,













Note:  (-) negative sign is prefixed to the formula because price and demand are inversely related. Doing this would bring the value of elasticity of demand positive. 

Interpretation:

The above calculated value of Elasticity of demand(Ed) is 6 >1 indicates elastic demand. It implies that a 1% fall in the price of a good causes a 6% increase in its demand showing that change in demand is greater than the change in price.

 

 Inelastic Demand

Demand will be inelastic when the percentage change in quantity demand for a commodity is less than the percentage change in the price for a commodity. In other words, it is when the change in quantity demand is less than the change in price. Examples of goods with inelastic demand are necessary goods such as food, fuel, medicines, etc.  Consumers will not reduce or postpone their consumption even if the price rises, although a shift in the use of other substitute goods could be seen.

 

Interpreting Inelastic demand

If the formula creates an absolute value that comes out to be less than 1, it will be an inelastic demand.

Inelastic Demand Example

Supposing the price of fuel increases from ₹ 10 to ₹ 14, (40%) the quantity demand decreases from 22 liters to 20 liters, (20%). What will be the elasticity of demand?

Using the Elasticity of demand formula,



























Note:  (-) negative sign is prefixed to the formula because price and demand are inversely related. Doing this would bring the value of elasticity of demand positive. 

Interpretation:

The above calculated value of Elasticity of demand(Ed) is 0.23 < 1 indicates inelastic demand. It implies that a 40% rise in the price of fuel causes a 20% decrease in its demand showing that change in demand is less than the change in price.



Let’s try some questions

Choose the Correct Answer

1. Ed > 1 represents?

a. Elastic demand  

b. Inelastic demand

c. Unitary elastic demand

d. None of above

2. Demand is inelastic if

a. a large change in quantity demanded results in a small change in price.

    b. the price elasticity of demand is greater than 1

    c. the quantity demanded is very responsive to changes in price

    d. the price elasticity of demand is less than 1.

3. When the percentage change in demand is more than the percentage change in price, demand will be

a. Elastic demand  

b. Inelastic demand

c. Unitary elastic demand

d. None of above

 

4. When the percentage change in demand is less than the percentage change in price, demand will be

a. Elastic demand  

b. Inelastic demand

c. Unitary elastic demand

d. None of above



5. Which of the following are the concepts of elasticity of demand?

a. Price elasticity of demand

b. Income elasticity of demand

c. Cross elasticity of demand

d. All of above




6. Availability of substitutes makes the demand

a. Elastic

b. Inelastic

c. Unitary elastic

d. None of above

 

7. Necessity goods make the demand

a. Elastic

b. Inelastic

c. Unitary elastic

d. None of above

 


Answer Key

 

1.a

2.d

3.a

7.b

4.b

5.d

6. a

 

 



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