Elasticity of demand

Introduction:

Elasticity is a central concept in economics, and is applied in many situations. Basic demand and supply
analysis explains that economic variables, such as price, income and demand, are causally related.
Elasticity can provide important information about the strength or weakness of such relationships.

Elasticity refers to the responsiveness of one economic variable, such as quantity demanded, to a change
in another variable, such as price

There are two types of elasticity ,they are

 The elasticity of demand

 The elasticity of supply

Price of Elasticity of demand:

Price elasticity of demand refers to the degree of responsiveness of quantity demanded to change in
price of the commodity. It quantifies the effect of change in price of a commodity on its demand. It
reflects how sensitive buyers are to change in price. The greater response, the greater will be the
elasticity.

In other words, the law of demand states that a fall in the price of good raises the quantity demanded
.the price elasticity of demanded measures how much the quantity demanded responds to a change in
price. Demand for a good is said to be elastic if the quantity demanded responds substantially to changes
in the price. Demand is said to be inelastic if the quantity demanded responds only slightly to changes in
the price.

The price elasticity of demand for demand for any good measures how willing consumers are to
move away from the good as its price rises. Thus, the elasticity reflects the many economic, social, and
psychological forces that shape consumer tastes. Based on experience, however, we can state some
general rules about what determines the price elasticity of demand.

The/re are two curves for good X and Y. both these curves are negative slopping. Let us assume that
prices of both goods x and y are px1 and py1(note that px1= py1).at price opx1, a consumer demands ox1
and , at price opy1,oy1 is demanded.
Now if prices of both X and Y decline by an individual amount to OPx2 and OPy2, respectively. But the
change in quantity demanded for good X is greater than the change in quantity demanded for good Y.this
means that good X is more sensitive or respective to a change in its price than good Y. this is called
elasticity of demand.

By elasticity of demand , we normally mean price elasticity of demand , elasticity of demand measures
-the degree of responsiveness of quantity demanded following a change in own price of the commodity,
h/--olding money income and prices of related goods constant.

Elasticity of demand is the relative difference in the dependent variable ( quantity) divided by the relative
difference in independent variable(price).alternatively , it is defined as the absolute value of the ratio
percentage change in price. thus, the elasticity of demand is a relative concept .

Formula for calculating elasticity of demand:

Ep= percentage changes in quantity demanded /percentage changes in price.

Prices of elasticity demanded(types):

 Elastic demand
 Inelastic demand
 Unitary elastic demand
 Perfectly elastic demand
 Perfectly inelastic demand

Elastic demand:(Ep>1)

Demand is said to be elastic if the change in price causes a more than proportionate
change in quantity demanded. A 10 p.c change in price causes quantity demanded to
change by more than 10 p.c . in other words , if E is greater than one, demand is said to be
elastic.
Normally, demand is elastic for luxury goods. Let the price of gold per gm decline from
rs.160 to rs.140. as a result , demand for gold rises from 1000 kilograms to 2000
kilograms. Thus,

Ep= 1000/1000 ÷ 20/160=1000/20.160/1000

=8

Since elasticity of demand for gold is greater than one , gold id luxury.

Inelastic demand (Ep<1):

When the change in price causes a less than proportionate change in quantity
demanded, demand id inelastic. A 10 p.c , cut in price may cause quantity demanded to fall
by1 p.c, thus, demand is said to be inelastic(Ep<1). Usually , demand is inelastic for
necessary goods.

Suppose that following a drop in the price of wheat from paisa 40 per kilogram to paisa 20
per kilogram, demand for wheat raises from 1600 kilograms to 2000 kilograms, this means
Ep=400/160÷20/40=400/20.40/1600

=0.5

Thus , wheat has an inelastic demand since Ep<1 and wheat is a necessary article.

Unitary elastic demand(Ep=1):

When the change in price causes the same proportionate change in quantity
demanded , demand has unit elasticity. A10 p.c decline in price will lead to an exactly 10
p.c increase in quantity demanded. Then Ep=1

Suppose that the price of a commodity declines from rs.200 to rs.100 per kilogram. As a
result , demand for that commodity rises from 400 kilograms to 800 kilograms.thus,

Ep=400/400÷100/100.100/400

=1

Perfectly elastic demand Ep=infinity):

When a slight change in price causes a great change in quantity demanded, the
value of elasticity of demand tends to be infinity and demand is said to be infinite or
perfectly elastic. In this case , the demand curve , becomes parallel to the horizontal axis.
Under perfectly competitive market, the demand curve for a product of a n individual firm
becomes perfectly elastic.
 Perfectly inelastic demand(Ep=0):

if quantity demanded becomes completely unresponsive to price changes , the

coefficient tends to be zero. In this case , whatever the price, even if it is zero, quantity
demanded will remain fixed at a particular level. The demand curve, thus , becomes
parallel to the vertical axis. And demand is said to be completely inelastic.

Thus , elasticity of demand varies from zero to infinity.

Factors determining elasticity of demand:

There are various factors on which elasticity of demand depends, they are

 Nature of commodity:

In the first place, it depends on the nature of the commodity. Commodities which
are supposed to be essential or critical to our daily lives must have an inelastic demand, since price
change of these items does not bring about a great change in quantity demanded.
But, luxury goods have an elastic demand. Demand for these goods can be quickly reduced when the
prices rise. When the prices fall, consumers demand these goods in larger quantities. However, whether a
particular commodity is a necessary or a luxury depends on income, tastes and preferences of the
consumer.

A particular good may be necessary to someone having an inelastic demand. Same commodity may be
elastic to another consumer. For instance, owning a TV may be luxury item to a low income person. But
the same may be bought as an essential item by a rich person.

 Availability of substitutes:
Secondly , commodities having large number of substitutes must have an
elastic demand. Some products , such as horlicks, complain, viva, maltova, milo
etc., have quite large number of close substitutes. A change in the price of
horlicks- the prices of other substitutes remaining constant- will lead to a
consumer to substitute one beverage for another
if the prices of horlicks goes down buyers will demand more of it and less of its
substitutes. Conversely , demand is fairly inelastic in the case of those commodities
which do not have large number of substitutes.

 Extent of uses:

There are some commodities which can be used for variety of purposes. For
example, electricity. If price per unit of electricity consumed falls, people will reduce their consumption
of its substitutes eg: coal ,gas, etc. and increase the consumption of electricity.

Coefficient of price elasticity of demand in this case must be greater than one.
On the other hand, when a commodity is used only for one or two purposes, a price change will have less
effect on its quantity demanded and therefore, demand will be inelastic.

 Habit good:

There are some commodities consumed out of habits and conventions-they

have an elastic demand. Even in the face of rising prices of those commodities or falling income, people
will consume those goods, such as cigarette.

For this reason , price elasticity as well as income elasticity of demand for this type of
commodity is inelastic. Further , gold ornaments are used in the marriage ceremony rather of convention
, though gold prices are rising . when gold is used in this way, its demand becomes inelastic.

 Time dimension:

Shorter the time , lower will be the elasticity of demand .this is because in the
short run satisfactory substitutes of a product may not be available . thus , demand for a product in the
short run usually becomes inelastic. Such commodity will be elastic in the long run whwn close
substitutes may be produced

Thus, the response of quantity demanded to a change in price will tend to be greater
(smaller),thelonger(shorter)_ the time span considered. In the long run , there is enough time for
adjustments to be made following a change in price