ELASTICITY OF DEMAND

Elasticity of demand may be defined as the ratio of the percentage change in demand to the
percentage change in price. Ep= Percentage change in amount demanded
Percentage change in price
TYPES OF ELASTICITY DEMAND

i. Price elasticity of demand: Elasticity of demand ma y be defined as the ratio of the

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

ii. Income elasticity of demand: The income elasticity of demand (Ey) express the responsiveness
of a consumer demand or expenditure or consumption) for any good to the change in his
income .it ma y be defined as the ratio of percentage change in the quantity demanded of a
commodity to the percentage in income. Thus

Ey = percentage change in quantity demanded / percentage change in income

iii. Cross elasticity of demand: The cross elasticity of demand is the relation between
percentage change in the quantity demanded of a good to the percentage change in the price of
a related good. The cross elasticity good A and good B is

Eba= percentage change in the quantity demanded of B/ percentage change in price of A

TYPES OF PRICE ELASTICITY OF DEMAND

i. Perfectly elastic demand: W here no reductio n in price is needed to cause an increase in

quantity demanded. This is explained with the help of a diagram.

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 X axis-quantity demanded
Y axis- price
DD1- demand curve

Explanation: Price elasticity of demand is infinity when a small change in price leads to an
infinitely large change in the amount demanded. It is perfectly elastic demand. [E=α]

ii. Perfectly in elastic demand: Here a large change in price causes no change in quantity
demanded. It is zero elastic demand [E=0]. This is explained with the help of a diagram.

X axis-quantity demanded
Y axis- price
DD1- demand curve

Explanation: The figure shows that even if the price decrease from p to p1 there is no
change in the quantity demand. This happens in case of necessities like salt.

iii. Unitary elastic: Where a given proportionate change in price causes an equally proportionate
change in quantity demand. This is explained with the help of a diagram.

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X axis-quantity demanded
Y axis- price
DD1- demand curve

Explanation: Price elasticity of demand is unity when the change in demand is exactly
proportionate to the change in price. [E=1].

iv. Relatively elastic: W here a small change in price causes a more than proportionate change in
quantity demanded. The price elasticity o f demand is greater than unity [E >1]. This is
explained with the help of a diagram.

X axis –quantity demanded

Y axis – price
DD –demand curve

Explanation: The figure shows that the re is a small decrease in price fro m P to P1, but it has
resulted in a large increase in quantity demanded from Q to Q1. It is also known as relatively
elastic demand.

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v. Relatively inelastic demand: W here a change in price causes a less than proportionate
change in quantity demanded. The price elasticity of demand is lesser than unity [E <1]. This
is explained with the help of a diagram.

X axis –quantity demanded

Y axis – price
DD- demand curve

Explanation: The figure shows that there is a large decrease in price from P to P1, but it has
resulted in only a small increase in quantity demanded from Q to Q1. It is also known as
relatively elastic demand.

TYPES OF INCOME ELASTICITY OF DEMAND

i. Positive and elastic income demanded: The value of the coefficient E is greater than unity ,
which means that quantity demanded of good X increases b y a larger percentage than the
income of the consumer. This is explained with the help of a diagram.

X axis –quantity demanded

Y axis – Income
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Explanation: The curve Ey shows a positive and elastic income demanded. In the case of necessities,
the coefficient of income of income elasticity is positive but low, Ey=1. Income elasticity of
demanded is low when the demand for a commodity rises less than proportionate to the rise in the
income.

ii. Positive but inelastic income demand: It is low if the relative change in quantity demanded is
less than the relative change in money income. Ey<1. This is explained with the help of a
diagram.

X axis –quantity demanded

Y axis – Income
DD- demand curve

Explanation: The curve Ey shows a positive but in elastic income demand. In the case o f
necessities, the coefficient of income elasticity is positive but low, Ey<1. Income elasticity of
demand is low when the demand for a commodity rises less than proportionate to the rises
less than proportionate to the rise income.

iii. Unitary income elasticity of demand: The percentage change in quantity demanded is equal to
the percentage change in money income. This is explained with the help of a diagram.

X axis –quantity demanded

Y axis – Income
DD- demand curve

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Explanation: The curve Ey shows unitary income elastic ity of demand. In the case of
comforts, the coefficient of income elasticity is unity (Ey=1) when the demand for a
commodity rises in the same proportions as the increases in income.

iv. Zero income elasticity: A change in income will have no effect on the quantity demanded.
The value of the coefficient Ey is equal to zero. This is explained with the help of a diagram.

X axis –quantity demanded

Y axis – Income
DD- demand curve

Explanation: The curve shows a vertical income, elasticity demand curve Ey with zero
elasticity
If with the increases in income, the quantity demanded remains unchanged the coefficient of
income elasticity, Ey=0.

v. Infe rior goods: Inferior goods have negative income elasticity of demand. It explains that
less is bought at higher inco mes and more is bought at lower incomes. The value of the
coefficient Ey is less than zero or negative in this case. This is explained with the help of a
diagram.

X axis –quantity demanded

Y axis – Income
DD- demand curve
Explanation: The coefficient of income elasticity of demand in the case of inferior goods is
negative. In the case o f an inferior good, the consumer will reduce his purchases of it, when
his income increases.

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DIFFERENT TYPES OF CROSS ELASTICITY OF DEMAND

A. CROSS ELASTICITY OF SUBS TITUTES : In case of substitutes, as the price of one

good increases the demand for the other good also increase at the same time.

i. Relatively elastic: Where a small change in price of good A causes a large change in quantity
demanded of good B. The elasticity o f substitutes is greater than unity [E >1].This is
explained with the help of a diagram.

X axis –quantity demanded of

B Y axis – price of A
DD –demand curve

Explanation: The figure shows that there is a small increase in price of good A from a to a1,
but it has resulted in a large increase in quantity demanded of B from b to b1. It is also known
as relatively elastic demand.

ii. Relatively inelastic demand: W here a large change in price of good A causes a small change
in quantity demanded of good B. The elasticity of substitutes is lesser than unity [E <1]. This
is explained with the help of a diagram.

X axis –quantity demanded of good B

Y axis – price of good A
DD- demand curve

Explanation: The figure shows that there is a large increase in price o f good A from a to a1,
but it has resulted in only a small increase in quantity demanded of good B from b to b1. It is
also known as relatively in elastic demand.

iii. Unitary elastic: Here a given proportionate change in price causes an equally proportionate
change in quantity demand. This is explained with the help of a diagram.
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X axis-quantity demanded of good B

Y axis- price of good A
DD- demand curve

Explanation: Price elasticity of demand is unity when the change in demand is exactly
proportionate to the change in price. [E=1].

iv. Perfectly in elastic demand: Here a large change in price causes no change in quantity
demanded. It is zero elastic demand [E=0]. This is explained with the help of a diagram.

X axis-quantity demanded of good B.

Y axis- price of good A.
DD- demand curve

Explanation: The figure shows that even if the price increases from a to a1 there is no
change in the quantity demand. This happens in case of necessities like salt.

v. Unrelated goods: If two goods are not at all related then they have negative elasticity of
demand. This is explained with the help of a diagram.

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X axis –quantity demanded of good B.

Y axis – Price of good A.
DD- demand curve

Explanation: The figure shows that in case on unrelated goods if the price of good A
increase from a to a1, then the demand for good B will decrease from b to b1.

B. CROSS ELAS TICITY OF COMPLIMENTAR Y GOODS: In case of complimentary

goods, as the price of o ne good increases the demand for the other good decreases at the
same time.

i. Perfectly elastic demand: W here no reduction in price is needed to cause an increase in

quantity demanded. This is explained with the help of a diagram.

X axis-quantity demanded of good B

Y axis- price of good A
DD- demand curve

Explanation: Price elasticity o f demand is infinity when a small change or no change in

price of good A leads to an infinitely large change in the amount demanded of good B. It is
perfectly elastic demand. [E=α]
ii. Perfectly in elastic demand: Here a large change in price of good B causes no change in
quantity demanded o f good B. It is zero elastic demand [E=0]. This is explained with the help
of a diagram.
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X axis-quantity demanded of good B

Y axis- price of good A
DD- demand curve

Explanation: The figure shows that even if the price of good B decreases from a to a1 there
is no change in the quantity demand of good A. This happens in case of necessities like salt.

iii. Unitary elastic: W here a given proportionate change in price causes an equally proportionate
change in quantity demand. This is explained with the help of a diagram.

X axis-quantity demanded of good B

Y axis- price of good A
DD- demand curve

Explanation: Price elasticity of demand is unity when the change in demand is exactly
proportionate to the change in price. [E=1].

iv. Relative ly elastic: Where a small change in price of good B causes a more than
proportionate change in quantity demanded of good A. The price elasticity of demand is
greater than unity [E >1].This is explained with the help of a diagram.
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X axis –quantity demanded of good B

Y axis – price of good A
DD –demand curve

Explanation: The figure shows that there is a small decrease in price fro m a to a1, but it has
resulted in a large increase in quantity demanded from b to b1. It is also known as relatively
elastic demand.

v. Relatively inelastic demand: W here a change in price causes a less than proportionate
change in quantity demanded. The price elasticity of demand is lesser than unity [E <1]. This
is explained with the help of a diagram.

X axis –quantity demanded of good B

Y axis – price of good A
DD- demand curve

Explanation: The figure shows that there is a large decrease in price fro m a to a1, but it has
resulted in only a small increase in quantity demanded from b to b1. It is also known as
relatively elastic demand.

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DIFFERENT METHODS OF MEASURING ELASTICITY OF DEMAND

1. Total outlay: According to this method, we compare the total outlay of the purchases or
total revenue, i.e, total value o f sales from the point of view of the seller before and after the
variations in price. This is explained with the help of a diagram.

X axis-------Quantity of X
Y axis---------price of X
DD------------demand curve

Explanation: If the elasticity of demand is equal to unity for all prices of the commodity
only fall in price will cause a proportionate increases in the amount bought, and therefore will
make no change in the total outlay which purchases make for the commodity thus one is the
dividing point. If the elasticity is greater than one it is said to be elastic and it is less than it is
inelastic curve having same elasticity throughout:-

2. Point elasticity: The concept of price elasticity can be used in comparing the sensitivity of
the different types of goods e.g., luxuries and necessaries) to changes in their prices. The
elasticity of demand is always negative because change in quantity demanded is in opposite
direction to the change in price that is a fall in p rice is followed b y rise in demanded and vice
versa hence elasticity less than zero.
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X axis Quantity of X
Y axis---------price of X
DD------------demand curve

Explanation:

Elasticity is represented b y fraction distance from d to a point on the curve divided b y the
distance from the other end to that point. Thus elasticity of demand is seen on the points P3,
P2and P1 respectively. It is seen that elasticity at a lower point on the curve is less than at a
higher point.

3. Arc elasticity: Arc elasticity is a measure of the average responsiveness to price changes
exhibited by a demand curve over some finite stretch of the curve. This is explained with the
help of a diagram below.

X axis Quantity of X
Y axis---------price of X
DD------------demand curve
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Explanation:-
i. Any two points on a demand curve make an arc the area between p and m on the DD curve is
an arc which measures elasticity over a certain range of prices and quantities.
ii. On any two points of a demand curve the price elasticity‘s of demand are likely to be
different depending upon how we calculate them.
iii. The closer the two points‘ p and m are, the more accurate will be the measure of elasticity.
iv. The arc elasticity is in fact the elasticity of the midpoint between p and m on the demand
curve .
v. If there is no difference between the two points and the y merge into each o ther o r coincide,
arc elasticity becomes point elasticity.

THE FACTORS DETERMING PRICE ELASTICITY OF DEMAND

i. Necessaries and conventional necessaries: people buy fixed quantities of such commodity
whatever is the price. The change in the price o f wheat ma y be immaterial for upper classes,
but its consumption will certainly increase among the poor when the price falls. It ma y be
noted that demand for a necessity life as a whole ma y be inelastic, but in a competitive
market, demand for the output of any particular firm is highly elastic. If it raises the price a
bit, it may lose the entire market.

ii. Demand for luxuries is elastic: It stands to reason that lowering of the price of things like
radio will lead to more bring bought i.e. the demand is elastic. Thus for the same article the
demand ma y be elastic for some people and inelastic for others elastic in one country and
inelastic in another and elastic at one time and inelastic at another.

iii. Proportion of total expenditure: It a consumption good absorbs only a small proportion of
total expenditure, eg, salt the demand will not be much affected b y a change in p rice hence, it
will be inelastic.

iv. Substitutes: The main cause of difference in the responsiveness of the demand for that there
are more completing substitutes for some goods than for others‖. When the price of tea
rises,
we may curtail its purchase and take of coffee, and vice versa. In a case like this a change in
price will lead to expansion or contraction in demand.

v. Goods having several uses: Coal is such a commodity when it will be used for several
purposes e. g, cooking heating and industrial purposes; and its demand will increase. But ,
when the price goes up, it use will be restricted only to very urgent uses and consequently
less will be purchased when the prices rises the demand will thus contract when wheat
becomes very cheap it can be used even as cattle feed hence demand for a commodity having
several uses is elastic

vi. Joint demand: If for instance, carriages beco me cheap but the prices of horses continue to
rule high, demand for carriage will not extend much. In other words the demand for jointly
demanded goods is less elastic.

vii. Goods the use of which can be postponed: Most of us during the war postponed our
purchases where we co uld e.g. building a house, buying furniture or having a number of
warm suits. We go in for such things in a large measure when the y are cheap demand for
such goods is elastic.

viii. Level of prices: If a thing is either very e xperience or very cheap, the demand will be in
elastic. If the price is too high, a fall in it will not increase the demand much. If on the other
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hand , it is too low, people will have alread y purchased as much as they wanted: any further
fall will not increase the demand.

ix. Market imperfections: Owing to ignorance about market trends the demand for a good may
not increase hen its price falls for the simple reasons that consumers ma y not be aware o f the
fall in price.

x. Technological factors: Low price elasticity ma y be due o some technical reasons. For
example lowering of elasticity ma y be electricity rates ma y not increase consumption because
the consumers are unable to buy the necessary electric appliances.

xi. Time period: The elasticity of demand is greater in the long run than in the short run for the
simple reasons that the consumer has more time to make adjustment in his scheme of
consumption. In other word he is able to increase or decrease his demand for a commodity

PRACTICAL APPLICATION (OR) IMPORTANCE (OR) SIGNIFICANCE OF

ELASTICITY OF DEMAND

i. Taxation: The tax will no doubt raises the prices but the demand being in elastic, people
must continue to buy the same quantity o f the commodity. Thus the demand will not
decrease.

ii. Monopoly prices: In the same manner, the businessman, especially if he is a monopolist, will
have to consider the nature of demand while fixing his price. In case I is in elastic, it will pay
him to him to change a higher price and sell a smaller quantity. If, on the other hand, the
demand is elastic he will lower the prices, stimulate demand and thus maximize his
monopoly net revenue

iii. Joint products: In such cases separate costs are not ascertainable the producers will be guided
mostly by demand and its nature fixing his price. The transport authorities fix their rates
according to this principle when we say that they charge what the ‗traffic will bear‘
iv. Increasing returns: W hen an industry is subject to increasing returns the manufacturer
lowers the price4 to develop the market so that he may be able to produce more and take full
advantage of the economies of large scale production.

v. Output: Elasticity o f demand affects industrial output reduction in price will certainly
increases the sale in the market as a whole.
vi. Wages: Easticity of demand also exerts its influence on wages. If demand for a particular
type of labour is relatively inelastic, it is easy to raise wages, but not otherwise.

vii. Poverty in plenty: The concept of elasticity explains the paradox of poverty in the midst of
plenty. This is specially so if produce is perishable. A rich harvest ma y actually fetch less
money a poor one.

viii. Effect on the economy: The working of the economy in general is affected b y the nature of
consumer demand. It affects the total volume of goods and services prod used in the country.
It also affects producers‘ demand for different factors of production their allocation and
remuneration.

ix. Economies policies: Modern governments regulate output and prices. The government can
create public utilities where demand is inelastic and monopoly element is present.
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x. International trade: The nature of demand for the internationally traded goods is helpful in
determining the quantum of again of gain accruing to the respective countries. Thus is how it
determines the terms of trade.

xi. Price determination: The concept of elasticity o f demand is used in explaining the
determination of price under various market conditions.

xii. Rate of foreign exchange: With fixing the rate o f exchange, the government has to consider
the elasticity or otherwise of its imports and exports.

xiii. Relation between price elasticity average revenue and marginal revenue: This
relationship enables us to understand and compare the conditions of equilibrium under
different market conditions.

xiv. Price determination: Price determination is forced to be profitable if elasticity o f demand in

another. The monopolist can charge a higher price in the market where elasticity o f demand is
less and a lower price where elasticity of demand is greater

xv. Measuring degree of monopoly power: The less is the elasticity of demand higher will be the
price and wider the difference between the marginal cost and greater the monopoly power,
and vice versa.

xvi. Classification of goods as substitutes and complements: Goods are classified as substitutes
on the basis of cross elasticity. Two commodities may be considered as substitutes if cross
elasticity is positive and complements when elasticity is negative.

xvii. Boundary between industries: Cross elasticity of demand is also useful in indicating
boundaries between industries. Goods with high cross elasticity‘s constitute one industry,
where as goods with lower elasticity constitute different industries.

xviii. Market forms: The concept of cross elasticity help[s to understand different market forms
infinite cross elastic ity indicates perfect market forms infinite cross elasticity indicates
perfect competitions, where as zero or hear zero elasticity indicates pure monopoly and high
elasticity indicates imperfect competition

xix. Incidence of taxes: The concept of elasticity o f demand is used in explaining the incidence
of indirect taxes like sales tax and excise duty. less is the elasticity of demand higher the
incidence, and vice versa. In case of inelastic demand the consumer have to buy the
commodity and must bear the tax.

xx. Theory of distribution: Elasticity of demand is useful in the determination of relative shares
of the various factors determination of relative shares of the various factors of production is
loss elastic, its share in the national dividend is higher, and vice versa. If elasticity of
substitution is high the share will be low.