UNIT 5: ELASTICITY OF DEMAND

CONTENTS
5.0 Aims and Objectives
5.1 Introduction
5.2 Meaning of Elasticity of Demand
5.3 Price Elasticity of Demand
5.4 Income Elasticity of Demand
5.5 Cross Elasticity of Demand
5.6 Measurement of Elasticity
5.7 Summary
5.8 Answers to Check Your Progress
5.9 Model Examination Questions
5.10 References

5.0 AIMS AND OBJECTIVES

In this unit we have presented the meaning of elasticity, types and the measurement of
elasticity. Once you complete this unit you will be able to;
 define the elasticity of demand;
 explain the price, income and cross elasticities of demand;
 measure the elasticity of demand.

5.1 INTRODUCTION

In microeconomics elasticity is used as a method to measure the degree of dependent

variables responsiveness to changes in an independent variable. Elasticity has various
applications most of them are interesting and useful in the study of consumption demand.

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5.2 MEANING OF ELASTICITY OF DEMAND

Elasticity –means responsiveness of demand to the change in price. It is a measurement

of the percentage of responsiveness of a dependent variable to a percentage change in an
independent variable.

KINDS OF ELASTICITY OF DEMAND

There are as many elasticity of demand as its determinants. The most important of these
elasticity are
1. Price elasticity of demand
2. Income elasticity of demand
3. Cross elasticity of demand

5.3 PRICE ELASTICITY OF DEMAND

It is a measure of the responsiveness of demand to changes in the commodity’s own

price. It can also be expressed as the ratio of a relative change in quantity to a relative
change in price. The formula for calculating the price elasticity of demand is:

Ep =

Ep =

Where Ep stands for price elasticity.

If the percentages are known quantities, then the numerical size of E can be easily
calculated. Let us suppose that the percentage increase in the quantity is 3 and the
percentage fall in the price is

1. then

Ep = = -3.

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KINDS OF PRICE ELASTICITY OF DEMAND

Price elasticity of demand is generally classified into five categories. They arte:
i) PERFECTLY ELASTIC DEMAND
It is a situation where the slightest rise in price
causes the quantity demanded of the
commodity to fall to zero. Similarly, the
slightest fall in price causes an infinite increase
in the quantity demanded of the commodity.
This type of cases are exceedi9ngly rare in the
world. It can be shown with the help of a
diagram. (see fig 5.1) here, demand curve is a

Fig 5.1 horizontal straight line.

ii) PERFECTLY INELASTIC DEMAND

In this case even substantial changes in the
price will not bring about any change in
demand. The demand in this case is
insensitive or not responsive to changes in
price. The elasticity of demand in this case is
zero. Like perfectly elastic demand, cases of
perfectly inelastic demand are also rare in
real life. It can be shown with the help of a
diagram also see diagram 5.2. In this case,
Fig. 5.2
the demand curve is a vertically straight line.

iii) RELATIVELY ELASTIC DEMAND

It is a situation where a small proportionate

change in the price of a commodity is
accompanied by larger proportionate
change in its quantity demanded. Elasticity
of demand here is said to be greater than

Fig. 5.3 unity. In can be shown in the diagram 5.3

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 iv) RELATIVELY INELASTIC DEMAND

It is a situation where a substantial

change in the price of a commodity is
accompanied by a smaller proportionate
change in its quantity demanded.
Elasticity of demand here is said to be
less than unity. It is shown in the diagram
5.4
Fig. 5.4

v) UNITARY ELASTIC DEMAND

It refers to a situation on where a given

proportionate change in price is
accompanied by an equally
proportionate change in the quantity
demanded. Elasticity of demand here is
said to be equal to unity. This is shown
in the diagram 5.5
Fig. 5.5
Table 5.1 PRICE ELASTICITY – MEASURES, MEANING AND NUMENCLATURE

Numerical measure Verbal Terminology

Of Elasticity Description
Zero quantity demanded does perfectly
not change as price changes inelastic
Greater than quantity demanded changes
Zero but less by a smaller percentage inelastic
than one than does price.

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One quantity demanded changes unit elasticity
by exactly the same
Percentage as does price.

Greater than quantity demanded changes elastic

one but less by a larger percentage
than infinity than does price

infinity purchasers are prepared to perfectly elastic

buy all they can obtain at
some price and none at all
at an even slightly higher price
Source: Richard G. Lipsey, An Introduction to Position Economics, ELBS, 1974, p.102

Basic determinants of price elasticity of demand

According to Koutsoyiannis, the basic determinants of the elasticity of demand of a

commodity with respect to its own price are:

1. The availability of substitutes: the demand for a commodity is more elastic if

there are close substitutes for it. it
2. The nature of the need that the commodity satisfies: in general, luxury goods
are price elastic while necessities are price inelastic.
3. The time period: demand is more elastic in the long run.
4. The number of uses to which commodity can be put: the more the possible
uses of commodity, the greater its price elasticity will be,
5. The proportion of income spent on the particular commodity

Check Your Progress –2

1. What is price elasticity of demand?

__________________________________________________________________
________________________________.

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5.4 INCOME ELASTICITY OF DEMAND

The responsiveness of demand to changes in income is termed as income elasticity of

demand. It can also be expressed as the proportionate change in the quantity demanded
resulting from a proportionate change in income.

Ey =

Symbolically, we may write

Ey =

For normal goods income elasticity is positive. Some of the writers have used income
elasticity in order to classify goods into “luxuries” and “: necessities”. A commodity is
considered to be a luxury if its income elasticity is greater than unity. A commodity is
necessity is its income elasticity is small.

The main determinants of income elasticity are:

1. The nature of the need that the commodity covers; the percentage of income spent
on food declines as income increases (this is known as Engel’s Law)
2. The initial level of income of a country: for example, a T>V> set is a luxury in an
underdeveloped country while it become a ‘necessity’ in a developed country.
3. The time period: Because consumption patterns adjust with a time-lag to changes
in income.

5.5 THE CROSS ELASTICITY OF DEMAND

It is the responsiveness of demand to change in the price of other commodities. It can

also be defines as the proportionate change in the quantity demanded of X resulting from
a proportionate change in the price of Y.

Exy =

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Cross elasticity may vary from minus infinity to plus infinity. Complementary goods will
have negative cross elasticities and substitute goods will have positive cross elasticities.
The main determinant of the cross elasticity is the nature of the commodities relative to
their uses. It two commodities can satisfy equally well the same need, the cross elasticity
is high and vice-versa.

5.6 MEASUREMENT OF ELASTICITY

There are three methods for the measurement of elasticity of demand they are

i) Total Outlay or Expenditure method

ii) Point method: and
iii) Arc method

TOTAL OUTLAY OR EXPENDITURE METHOD

This method is associated with the name of Alfred Marshall according to which we
measure the elasticity by examining the change in the total expenditure due to a change in
price. We can observe this in the following demand schedule.

Table 5.2: Demand Schedule for Tooth Brushes

Price per Number demanded Total amount
Tooth Brush spent
Br. 2=00 2 Br. 4=00……(1)
Br. 1=00 3 Br. 3=00…….(2)
Br. 0=75 4 Br. 3=00…….(3)
Br. 0=62 5 Br. 3=10……..(4)

In the above schedule, the total amount of money spent decreased with a fall in the price
(increases with a rise in price) from Br 2=00 to Br.1=00, the total amount spent decreased
from Birr 4=00 to Br.3=00. In this case the elasticity is said to be less than unity. In
between (2) and (3) the total amount of money spent remained the same. It means that
when the price decreased from Birr. 1=00 to Br. 0=75, the total expenditure remained at
Br.3=00. In this case, the elasticity is said to be equal to unity. In between (3) and (4) the

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total amount of money spent increase with a fall in price (or deceases with a rise in price)
the elasticity is said to be greater than unity. The total amount spent increased from
Br.3=00 to Br3=10. this method can also be represented with the help of a diagram

In the diagram 5.6, total expenditure is

measured along OX axis and price along the
OY axis. We get a backward sloping curve
“OLUM”. The portion ‘OL’ represents less
than unitary elasticity, because an increase in
price decreases the total expenditure. The
‘LU’ paroation represents unitary elasticity
because a change has no effects on the total
expenditure, as it remains constant. The
portion ‘UM’ represents elasticity more than

Fig. 5.6 unity, because an increase in price decreases

the total expenditure and a decrease in price
increases the total expenditure.
THE POINT METHOD
The method is also suggested by Alfred Marshall. In this method, we take a straight-line
demand curve joining the two axes, and measure the elasticity between two points Q and
Q1 which are assumed to be intimately close to each other.

In the diagram 7.7 ‘RP’ is the straight line

demand curve which connects both the
axes. In the beginning at the price QM, the
quantity demanded is OM. Then the price
changes to Q1M1 and the new quantity
demanded is OM1. the symbol ‘P’
represents the change in price while the
symbol ‘Q’ shows the change in quantity
demanded. The price elasticity of demand
can be determined by the following
Fig. 5.7 formula.

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 Ed =

The percentage change in quantity demanded can be found out thus:

The percentage change in price can be found out thus:

= =

Ed = =

On a straight-line demand curve we can make use of this formula to find out the price
elasticity at any particular point. We can find out numerical elasticites also on different
points of the demand curve with the help of the above formula. It should be remembered
that the point elasticity of demand on a straight line is different at every point. Elasticity
at any one point is the ratio of the lower part of the straight line demand curve, it is called
point elasticity of demand.

ARC METHOD
The main drawback of the point method is that it is applicable only when we possess
information about even the sli9ght changes in the price and the quantity demanded of the
commodity. But in practice, we do not possess such information about minute changes.
We may possess demand schedules in which there are big gaps in price as well as the
quantity demanded. In such cases, therefore is an alternative method known as arc
method of elasticity measurement. In this method the midpoints between the old and the
new data in the case of both price and quantity demanded are used. It studies a portion or
a segment of the demand curve between the two points. An arc is a portion of a curve
line, hence, a portion or segment of a demand curve. The formula for measuring arc
elasticity is given below.

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Ed =

Symbolically, the formula may be expressed thus:

Ed =

Here, Q = Original Quantity demanded

Q1 = New quantity after change in price
P = New price after change
P1 = New price after change

We can take a numerical example to illustrate arc elasticity. Suppose that the price of a
commodity in Br. 5 and the quantity demanded at that price is 100 units of a commodity.
Now assume that the price of the commodity falls to Birr. 4/- and the quantity demanded
rises to 110 units. In terms of the above formula, arc elasticity, then, will be

Ed =

=-

5.7 SUMMARY

This unit has discussed the meaning of elasticity and three kinds of demands. The price
elasticity of demand explains the responsiveness of demand due to changes in price. The
relationship between relative change in demand and proportionate change in income is

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explained by income elasticity of demand. Cross elasticity measures the responsiveness
of demand for a commodity due to change in the price of other related commodity.

5.8 ANSWERS TO CHECK YOUR PROGRESS

1.

5.9 MODEL EXAMINATION QUESTIONS

1. What do you mean by elasticity of demand?

2. Explain the types of elasticity of demand?
3. What is price elasticity of demand?
4. Explain cross elasticity of demand?
5. What are the determinants of price elasticity of demand?

5.10 REFERENCES

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