Elasticity of Demand :
Elasticity of Demand measures the extent to which quantity demanded of a commodity increases or decreases in response to increase or decrease in any of its quantitative determinants.
Formula :
Elasticity of Demand = % change in quantity demand of ‘X’ / % change in factors affecting demand for ‘X’
Accordingly, elasticity of demand can be of three types ;
- Price Elasticity of Demand
- Income Elasticity of Demand and
- Cross Elasticity of Demand.
Price Elasticity of Demand and its different types of degrees :
Price Elasticity of Demand is percentage change in demand divided by percentage change price. It tells us percentage falls in demand due to percentage rise in price and percentage rise in demand due to percentage fall in price. According to Marshall, “Elasticity of Demand may be defined as the percentage change in the quantity demanded divided by the percentage change in the price.
By formula : Ed = % change in quantity demanded/ % change in price
Or
Ed = ∆Q/∆P × P/Q
Here, ∆Q = Change in Demand
∆P = Change in Price
P = Initial Price
Q = Initial Demand
[Note: The Price elasticity of demand is always in negative because of inverse relationship between price and quantity demanded].
Degrees of Price Elasticity of Demand/ Types of Price Elasticity of Demand :
In economics five cases of elasticity of demand are studied depending upon their degrees –
I. Perfectly Elastic Demand (Ed = ♾) :
A perfectly Elastic demand refers to the situation when demand is infinite at the prevailing price. In this situation quantity may increase or decrease with the constant price. In this, price elasticity of demand is infinite and demand curve is a horizontal straight line parallel to X-axis.
II. Perfectly Inelastic Demand (Ed = 0) :
A perfectly inelastic demand is one in which a change in price causes no change in the quantity demanded. It is a situation where even substantial changes in price leave the demand unaffected. In this case, price elasticity of demand is zero and demand curve will be vertical straight line parallel to Y-axis.
III. Unitary Elastic Demand (Ed = 1) :
Unitary Elasticity of Demand is one in which a percentage change in price is equal to percentage change in demand. In other words, a given proportionate fall in price is followed by the same proportionate rise in demand and vice versa. In this case, price elasticity of demand is equal to one and demand curve is a rectangular hyperbola. For example, if quantity demanded rises by 10% due to fall in price of the commodity by 10%, then Ed will be,
= % change in quantity demanded/ % change in price
= 10/10 = 1
Or Unitary Elastic Demand (Ed = 1)
IV. Greater than Unitary Elastic Demand (Ed >1):
When percentage change in quantity demand is greater than percentage change in price, then price elasticity of demand is known as greater than Unitary Elastic Demand or highly elastic demand. In other words, a given small proportionate fall in price is followed by a larger proportionate increase in demand and vice versa. For example, if quantity demanded rises by 20% due to fall in price of the commodity by 10%, then Ed will be,
= % change in quantity demand/ % change in price
= 20/10 = 2
Or Highly Elastic Demand (Ed > 1)
V. Less than Unitary Elastic Demand :
When percentage change in quantity demand is less than percentage change in price, then price elasticity of demand is known as less than Unitary Elastic Demand or less elastic demand. In other words, a given larger proportionate fall in price is followed by a smaller proportionate increase in demand and vice versa. For example, if quantity demanded rises by 10% due to fall in price of the commodity by 20%, then Ed will be,
= % change in quantity demand/ % change in price
= 10/20 = 0.5
Or Less Elastic Demand (Ed < 1)
Factors influencing the price Elasticity of Demand :
Following factors determine the price elasticity of demand –
- Nature of Commodity : Ordinarily, necessities like salt, match boxes, books etc. have inelastic demand. Luxuries, like air-conditioners, costly furniture etc., have greater than Unitary Elastic Demand. The reason being that change in their price has a great effect on their demand.
- Availability and Number of Substitutes : Demand for those commodities which have substitutes, are relatively more elastic. The reason being that when the price of commodity falls in relation to its substitutes the consumers will go for it and so its demand will increase. Commodities having no substitutes like cigarettes, liquor etc. have inelastic demand.
More the number of substitutes available of a good, higher is its price elasticity of demand because in case of price change, the consumers can conveniently shift from one substitute to another. For example, Pepsi has many close substitutes like Coke, Limca etc. if its price goes up, people can shift to other brands of cold drinks. Therefore, demand for Pepsi is elastic. If close substitutes of a good are not available easily in the market, the demand for the good is likely to be inelastic. For example, demand for salt is inelastic.
- Different Uses of Commodity : Commodities that can be put to a variety of uses have elastic demand. For example, electricity has multiple uses. It is used for lighting, room heating etc. If the traffics of electricity increase its use will be restricted to important purposes like lighting. It will be withdrawn from less important uses.
- Income Level of the Consumers : People whose incomes are very high or very low, their demand will Ordinarily ne inelastic. Because rise or fall in price will have less effective in their demand. Conversely middle income groups will have elastic demand.
- Habit of Consumers : Goods to which a person becomes habitual will have inelastic demand like cigarettes, coffee, tobacco etc. It is so, because a person has become habitual of them and cannot live without them.
- Price Level : Elasticity of Demand will be high at higher level of the price of the commodity and low at the lower level of the price.
- Time Period : Demand is inelastic is short period because a consumer can not change his consumption habits in short period. On the contrary, demand is elastic in long period because a consumer can change his consumption habits in long period.