Elasticity of Demand

Elasticity of Demand
Simply Elasticity is the responsiveness of one variable to changes in another
Elasticity

of Demand is a measure of how much change in demand has been occurred due to change in the price of a commodity.

3 Basic types of Elasticity

Price elasticity of demand Income elasticity of demand Cross elasticity of demand

Price Elasticity of Demand

Price

elasticity of demand is the percentage change in quantity demanded given a percent change in the price.
is a measure of how much the quantity demanded of a good responds to a change in the price of that good.

It

Computing the Price Elasticity of Demand

The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price.

Price Elasticity = Of Demand

Percentage Change in Qd
Percentage Change in Price

Thus the price elasticity of demand is always negative

Computing the Price Elasticity of Demand

Price elasticity of demand Percentage change in quatity demanded Percentage change in price

Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones then your elasticity of demand would be calculated as:

(10 8 ) 100 20 percent 10 2 ( 2.20 2.00 ) 100 10 percent 2.00

Degrees of Price Elasticity

Perfectly Elastic Demand

0 Quantity

Perfectly Inelastic Demand

- Elasticity equals 0
Price

Demand

$5 1. An increase in price... 4

Quantity 100 2. ...leaves the quantity demanded unchanged.

Inelastic Demand
- Elasticity is less than 1
Price

1. A 25% $5 increase in price... 4 Demand

Quantity 90 100 2. ...leads to a 10% decrease in quantity.

Unit Elastic Demand

- Elasticity equals 1
Price

1. A 25% $5 increase in price... 4 Demand

Quantity 75 100 2. ...leads to a 25% decrease in quantity.

Elastic Demand
- Elasticity is greater than 1
Price

1. A 25% $5 increase in price... 4 Demand

Quantity 50 100 2. ...leads to a 50% decrease in quantity.

Measurement of Price Elasticity of Demand

Total Expenditure Method / Total Outlay Method
Percentage / Proportionate / Flux / Ratio Method

Point Method / Geometrical Method / Graphic Method

Arc Elasticity

Revenue Method

Determinants of Price Elasticity of Demand

Necessities versus Luxuries Availability of Close Substitutes Time Horizon

Complementary Goods / Joint Goods

Proportion of the Income spent on a Commodity

Durability of Goods
Postponement of Uses

Income Elasticity of Demand:

EY = Proportionate Change in Quantity Demanded Proportionate Change in Income

Types:

Normal Goods Income Elasticity is positive. Inferior Goods Income Elasticity is negative. Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods.

Cross Elasticity

The responsiveness of demand of one good to changes in the price of a related good either a substitute or a complement
% change in Quantity demanded of X Good % change in Price of Y Good

EC =

Positive-Substitutes Negative-Complements

Advertising Elasticity
In case of various products and services, the market demand is influenced by advertisement or promotional efforts. Advertising elasticity is the degree of responsiveness of demand to changes in advertising. EA DX = f(AX) = Proportionate Change in Quantity Demanded of Good X Proportionate Change in Expenditure on Advertising Good - X If E = 1 If E > 1 If E < 1 If E = 0

Cross-Advertising Elasticity

This measures the responsiveness of a change in advertising expenditure on good B upon the demand for good A. DA = f (AB)
Proportionate Change in Quantity Demanded of Good - A Proportionate Change in Expenditure on Advertising Good - B

ECA=

The value could be positive or negative. It depends upon the relationship between the goods. In case of substitute goods there will be negative relation, on the other hand in case of complementary goods there is positive relation.