Elasticity of Demand

Elasticity of demand refers to the sensitiveness or responsiveness of demand

to changes in price. Price elasticity of demand is usually referred to as elasticity of
demand. Also, there is income elasticity of demand and cross elasticity of demand.
Thus it is the percentage change in quantity demanded divided by the percentage in one of the
variables on which demand depends

i) Price Elasticity of Demand

It is the ratio of proportionate change in quantity demanded of a commodity to

a given proportionate change in its price. Price elasticity of demand (E P ) is, thus,
given by:
Percentage Change in Quantity Demanded
Ep =
Percentage Change in Price
or in symbolic terms,
Δ Q P Δ Q P
Ep = = = x = x
Δ
Δ P x 100 Δ P Q Δ P Δ P Q
Δ
P P
Q
Q
x
Where, Q = quantity demanded of a commodity; P=Q Price.
Let us suppose that a consumer 1
demands 10 oranges when its unit price is Re.
1. If its price falls to 95 paise, he0 demands 12 oranges. Now, the price elasticity
0 2 /10 x100 20
of demand can be estimated as follows: Ep = = = -4
Q -5 /100 x100 -5
 As the price falls by 5 per cent, the quantity demanded raises by 20 per cent.
Now, the coefficient of elasticity of demand is minus 4. Thus, it could be concluded
that there is a four per cent increase in the quantity demanded of orange due to
one per cent decrease in its price.

a) Types of Elasticity of Demand: Price elasticity of demand is classified under

the following five sub heads:
1. Perfectly elastic demand: It refers to the situation where the slightest rise in
price causes the quantity demanded of a commodity to fall to zero and at the present
level of price people demand infinitely large quantity of the commodity. The
coefficient of elasticity of demand is infinite.
Price

Price
P0 P1
P0

E Q0 Q1 E Q0
p Quantity Demanded p Quantity Demanded
Fig. 3.8(a) Perfectly Elastic Fig. 3.8(b) Perfectly Inelastic
= =
2. Perfectly inelastic demand: It refers to the situation where even substantial

changes in price do not make any change in the0 quantity demanded, i.e., for any
change in the price, the demand remains constant. The coefficient of elasticity of
demand is zero.

3. Relatively elastic demand: Here, a small proportionate change in the price of a

commodity results in a larger proportionate change in its quantity demanded. The
coefficient of elasticity of demand is greater than unity.

4. Relatively Inelastic demand: A larger proportionate change in the price of a

commodity results in a smaller proportionate change in its quantity demanded. The
coefficient of elasticity of demand is greater than zero, but less than unity.

5. Unitary elastic demand: It refers to a situation where a given proportionate

change in price is accompanied by an equally proportionate change in the quantity
demanded. In other words, a given proportionate fall in the price is followed by an
equally proportionate increase in demand and vice versa. The co efficient of elasticity of demand is
unity.
 Price
P0
P1
P
ri

Price
0E Q0 Q1 0
P0
Q0 Q1
Quantity
p Demanded Quantity
0
Demanded
Fig.3.8(c) Relatively Elastic P<
Fig.3.8 (d) Relatively
> 1
Inelastic
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Uses of Elasticity of Demand

1) The business firms take into account the elasticity of demand when they take
decisions regarding pricing of goods.

2) The elasticity of demand concept is used by the government in economic

policy regarding regulation of prices of farm products.

ii) Income Elasticity of Demand

It may be defined as the ratio of proportionate change in the quantity demanded
of commodity to a given proportionate change in income of the consumer.

Percentage Change in Quantity Demanded

Income Elasticity, Ei =
Percentage Change In Income
ΔQ x 100

Q Δ Q Y Δ Q Y
Symbolically, Ei = = x = x
Δ Y x 100 Q Δ Y Δ Y Q
Y
Where, Q = Quantity demanded; Y-income

If, for instance, consumer’s income rises from Rs. 1000 to Rs. 1200, his purchase of the
good X (say, rice) increases from 25 kgs per month to 28 kgs, then his income elasticity of
demand for Rice is:

3 1000
Ei = x = 0.60
200 25
From this, we conclude that, the quantity demanded of rice rises by 0.60
per cent, if the income of the consumer rises by one per cent. Income
elasticity of demand can be divided into following five sub-heads:

a) Types of Income Elasticity of Demand

1) Zero income elasticity: A given increase in the consumer’s

money income does not result in any increase in the quantity demanded
of a commodity (Ei=0).

2) Negative income elasticity: A given increase in the consumer’s money

income is followed by an actual fall in the quantity demanded of a
commodity. This happens in the case of economically inferior goods
(E i < 0).

3) Unitary income elasticity: A given proportionate rise in the

consumer’s money income is accompanied by an equally proportionate
rise in the quantity demanded of a commodity and vice versa (Ei=1).

4) Income elasticity of demand greater than unity: For a given

proportionate rise in the consumer’s money income, there is a greater

proportionate rise in the quantity demanded of a commodity. Ei is
greater than unity. This is in case of luxuries.

5) Income elasticity of demand less than unity: For a given

proportionate rise in the consumer’s money income, there is a smaller
proportionate rise in the quantity demanded of a commodity. The
income elasticity of demand is less than
Income

D D D
I E I EI
I I E
0 i 0 i D
1
D
I1 =
1
<0 i
0 =
0 1

0 Q0 0 Q0 Q1 0 Q0 Q1
Quantity Demanded of a
Commodity
Fig (a) Zero Income Fig (b )Negative Income. Fig (c)Unitary
Elasticity of Demand Elasticity of Demand Income Elasticity
of Demand
 unity in case of necessaries i.e., the percentage expenditure on
necessaries increases in a smaller proportion when the consumer’s
money income goes up (Ei < 1).
Income

Income
II E
0I E Q0 Q1 0 Q 0 Q1
I I
1
0 Quantity Demanded of
0 a Commodity
1
> Income Elasticity Greater < Fig (e) Income Elasticity Less than Unity
Fig (d)
1 1
than Unity

iii. Cross Price Elasticity of Demand

Cross Elasticity of Demand measures the responsiveness of demand for one good to the change in
the price of another good. It is the ratio of the percentage change in quantity demanded of Good X
to the percentage change in the price of Good Y.
It is a measure of relative change in the quantity demanded of a commodity due to
a change in the price of its substitute/complement. It can be expressed as:
 Types of Cross Elasticity of Demand:
1. Positive:

When goods are substitute of each other then cross elasticity of demand is positive. In other words, an
increase in the price of Y leads to an increase in the demand of X. For instance, with the increase in
price of tea, demand of coffee will increase. In fig. 21 quantity has been measured on OX-axis and
price on OY-axis. At price OP of Y-commodity, demand of X-commodity is OM. Now as price of Y
commodity increases to OP1 demand of X-commodity increases to OM 1 Thus, cross elasticity of
demand is positive.

2. Negative:

In case of complementary goods, cross elasticity of demand is negative. A proportionate increase

in price of one commodity leads to a proportionate fall in the demand of another commodity
because both are demanded jointly. In fig. 22 quantity has been measured on OX-axis while price
has been measured on OY-axis. When the price of commodity increases from OP to OP1 quantity
demanded falls from OM to OM1. Thus, cross elasticity of demand is negative.
3. Zero:

Cross elasticity of demand is zero when two goods are not related to each other. For instance,
increase in price of car does not affect the demand of cloth. Thus, cross elasticity of demand is
zero. It has been shown in fig. 23.