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Elasticity of Demand

September 22, 2021
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PRICE ELASTICITY OF DEMAND (Ed)

Price elasticity of demand means the degree of responsiveness of demand for a commodity with reference to a change in its price.

The price elasticity of demand for a good is defined as the percentage change in quantity demanded for the good divided by the percentage change in its price.

 

It is a pure number and has no units.

Percentage Method for measuring price elasticity of demand

According to this method, elasticity is measured as the ratio of percentage change in the quantity demanded of a good to percentage change in its price.

Ed = \frac{% Change in Quantity Demanded}{%Change in Price} X 100 = \frac{\Delta Q}{\Delta P} X \frac{P}{Q}

Where:

  1. Change in Quantity (∆Q) = Q1 – Q0.
  2. Change in Price (∆P) = P1 – P0
  3. Percentage change in Quantity demanded =   \frac{Change in Quantity(\Delta Q)}{Initial Quantity (Q)}X100 = \frac{\Delta Q}{Q}X100
  4. Percentage change in Price =  \frac{Change in Price (\Delta P)}{Initial Price (P)}X100 = \frac{\Delta P}{P}X100

For example: If price elasticity of demand is (-) 2, it means that one percent fall in price leads to 2 percent rise in demand or one percent rise in price leads to 2 percent fall in demand.

The value of price elasticity of demand (Ed) is always negative because of the inverse relationship between change in price and change in quantity demanded.

Degrees of price elasticity of demand

Name Value Remark
1. Perfectly Inelastic Demand Ed = 0 % change in quantity demanded = 0
2. Inelastic Demand Ed < 1 % change in quantity demanded < % change in price
3. Unit Elastic Demand Ed = 1 % change in quantity demanded = % change in price
4. Elastic Demand Ed >1 % change in quantity demanded > % change in price
5. Perfectly Elastic Demand Ed = ∞ There is infinite change in quantity demanded.

Demand curves with same value of price elasticity of demand all along the demand curve

1) Perfectly inelastic demand 

 

 

When the percentage change in quantity demanded is zero, no matter how price is changed, the demand is said to be perfectly inelastic.

2) Perfectly elastic demand

When the percentage change in quantity demanded is infinite even if the percentage change in price is zero, the demand is said to be perfectly elastic. Infinite demand at given price.

3) Unit elastic demand

 

 

When the percentage change in quantity demanded is equal to percentage change in price. In a rectangular hyperbola, area of rectangles formed under the curve are equal i.e expenditure (P x Q) remains same.

4) Relatively elastic demand :-

 It refers to the situation when proportionate change in quantity demand is greater than the proportionate change in price. Elasticity of demand is greater than one.

5) Relatively inelastic demand :-

It refers to the situation when proportionate change in quantity demand is greater than the proportionate change in price. Elasticity of demand is greater than one.

Factors affecting price elasticity of demand

Nature of commodity: Elasticity of demand of a commodity is influenced by its nature.

    • When a commodity is a necessity like food grains, vegetables, medicines, etc., its demand is generally inelastic as it is required for human survival and its demand does not change much with change in its price.
    • Luxuries will have more elastic demand as its demand varies greatly with a change in its price.
    • Commodities, which have become habitual necessities for the consumers, have less elastic or inelastic demand. It happens because such a commodity becomes a necessity for the consumer and he continues to purchase it even if its price rises. Alcohol, tobacco, cigarettes, etc. are some examples of habit forming commodities.

 

Number of substitutes : More is the number of substitutes of a good, more is its price elasticity of demand.

  • The reason is that even a small rise in its price will induce the buyers to shift the demand to its substitutes. For example: A rise in the price of Pepsi encourages buyers to buy Coke and vice-versa.
  • Commodities with few or no substitutes like wheat and salt have less elastic or inelastic demand.

 

Number of uses: More is the number of uses of a good, more is the price elasticity of demand.

    • When price of such a commodity increases, its number of uses can be reduced, thus reducing its demand. When its price falls, the number of uses it is put to, can be increased, thus increasing its demand.
    • For example: Milk can be put to many uses like making cheese, butter, curd, icecreams or drinking as it is and so on. In case of a rise in price of milk, some of these uses can be cut down, thereby reducing its demand, while in case of a price fall, it can be put to more number of uses, thus increasing its demand. Thus, demand for milk is elastic.

 

Income level: Higher is income level more inelastic will be the demand for any commodity.

    • It happens because rich people are not affected much by changes in the price of goods. But poor people with lesser incomes are highly affected by a change in the price of goods as it will affect their budget significantly. As a result, demand for lower income group is highly elastic.

 

Proportion of income spent on a commodity : Higher is the proportion of income spent on a commodity, more will be its price elasticity of demand.

    • Demand for goods like salt, needle, soap, matchbox, etc. tends to be inelastic as consumers spend a very small proportion of their income on such goods. When prices of such goods change, consumers continue to purchase almost the same quantity of these goods as it does not affect their budget significantly.
    • However, if the proportion of income spent on a commodity is large, then demand for such a commodity will be elastic as it will affect their budget significantly.

 

Time period: More is the time period, more will be the price elasticity of demand.

    • Demand is generally inelastic when the time period is short. It happens because consumers find it difficult to change their habits, in the short period, in order to respond to a change in the price of the given commodity.
    • However, demand is more elastic in the long-run as it is comparatively easier to shift to other substitutes if the price of the given commodity rises.

Consumption postponement:- The demand for goods whose consumption can be postponed for the coming future is more elastic.
Example:- If the demand for building houses can be postponed for the coming future, then the demand for sand, cement, brick etc. will be elastic. But if the use of the commodity cannot be postponed for the foreseeable future, their demand becomes inelastic.

Consumer Habit:- The things people get used to like- paan, cigarette, tea etc. Their demand is inelastic because the consumer cannot live without the use of these goods.

Recap :-

  • The price elasticity of demand for a good is defined as the percentage change in quantity demanded for the good divided by the percentage change in its price. The elasticity of demand is a pure number.
  • Factors affecting Price Elasticity of Demand

(a) Nature of the commodity (b) Number of substitutes. (c) Income Level (d) Number of uses

(e) Proportion of income spent on a commodity (f) Time Period (g ) Consumer Habit

(h )Consumption postponement

 

 

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