Elasticity of Demand

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The elasticity of demand is an economic term. It refers to demand sensitivity. In other words, it helps to
understand how the demand for good changes is when there are changes in other economic variables. These
economic variables include factors such as prices and consumer income.

Demand elasticity is calculated as the percent change in the quantity demanded divided by a percent change
in another economic variable.  A higher value for the demand elasticity with respect to an economic variable
means that consumers are more sensitive to changes in this variable.

The elasticity of demand = (% Change in demanded quantity)/ (% Change in another economic variable)

Types of Demand Elasticity

Let us take a look at the types of demand elasticity. There are broadly three types of demand elasticity.

1] Price Elasticity of Demand

This refers to the change or sensitivity in the customer’s demand for the quantity of a good with respect to a
change in its price. Companies often collect this data on the consumer response to price changes. This
helps them adjust the price to maximize profits.
2] Income Elasticity of Demand

This is the responsiveness of demand for a product with respect to the change in income. So it will help
measure the increase or decrease in demand when the income of the consumer increases or decreases.

3] Cross Elasticity of Demand

This value is calculated by using the percent change in demanded quantity for a good and dividing it by the
percent change in the price of some other good. Moreover, this indicates the consumer reaction to demand a
particular good in accordance with price changes of other goods.

Demand elasticity is generally measured in absolute terms. This implies the sign of the variable is ignored. If
the value is greater than 1, it is elastic. Furthermore, this implies demand is responsive to economic changes
(like price). If the value is less than 1 is inelastic.

This further implies demand does not show change according to economic changes such as price. Demand is
unit elastic when its value is equal to 1. This implies the value of demand moves proportionately with
economic changes.

Law of Demand

Economists use the term demand as a reference to the quantity of a good or service that a consumer is willing
and has the ability to purchase at a price. Demand is based on needs and the ability to pay. Ability to pay is
important as in its absence the demand becomes ineffective.

The law of demand states that if all other factors remain constant, then the price and the demanded quantity
of any good and service are inversely related to one another. This implies that if the price of an article
increases then its corresponding demand decreases. Similarly, if the price of an article decreases then its
demand should increase accordingly.

The price of the good and its price are plotted to form the demand curve.  The demand quantity at a particular
price can be calculated from the demand curve. This price and value relation is represented in a table known
as the demand schedule.

Solved Question for You

Q: What is Ceteris Paribus?

Ans: It is important to take into account the assumptions made while constructing the law of demand. A
primary assumption is ‘Ceteris paribus’. This implies that everything aside from price remains constant and
no change in any other economic variable. Furthermore, the change in the demanded quantity is only due to a
change in prices.
Elasticity of Demand
A change in the price of a commodity affects its demand. We can find the elasticity of demand, or the degree
of responsiveness of demand by comparing the percentage price changes with the quantities demanded. In
this article, we will look at the concept of elasticity of demand and take a quick look at its various types.

Elasticity of Demand

To begin with, let’s look at the definition of the elasticity of demand: “Elasticity of demand is the
responsiveness of the quantity demanded of a commodity to changes in one of the variables on which
demand depends. In other words, it is the percentage change in quantity demanded divided by
the percentage in one of the variables on which demand depends.”

The variables on which demand can depend on are:

 Price of the commodity

 Prices of related commodities

 Consumer’s income, etc.

Let’s look at some examples:

a. The price of a radio falls from Rs. 500 to Rs. 400 per unit. As a result, the demand increases from 100
to 150 units.

b. Due to government subsidy, the price of wheat falls from Rs. 10/kg to Rs. 9/kg. Due to this, the
demand increases from 500 kilograms to 520 kilograms.
In both cases above, you can notice that as the price decreases, the demand increases. Hence, the demand for
radios and wheat responds to price changes.

Types of Elasticity of Demand

Based on the variable that affects the demand, the elasticity of demand is of the following types. One point to
note is that unless otherwise mentioned, whenever the elasticity of demand is mentioned, it implies price
elasticity.

Price Elasticity

The price elasticity of demand is the response of the quantity demanded to change in the price of a
commodity. It is assumed that the consumer’s income, tastes, and prices of all other goods are steady. It is
measured as a percentage change in the quantity demanded divided by the percentage change in price.
Therefore,

$$\text{Price Elasticity} = E_p =  \frac{\text{Percentage change in quantity demanded}}{\text{Percentage

change in price}}$$

Or,

Ep=Change in Quantity×100Original QuantityChange in Price×100Original Price

=Change in QuantityOriginal Quantity×Original PriceChange in Price

Income Elasticity

The income elasticity of demand is the degree of responsiveness of the quantity demanded to a change in the
consumer’s income. Symbolically,

EI=Percentage change in quantity demandedPercentage change in income

Cross Elasticity

The cross elasticity of demand of a commodity X for another commodity Y, is the change in demand of
commodity X due to a change in the price of commodity Y. Symbolically,

Ec=ΔqxΔpy×pyqx
Where,

Ec
 is the cross elasticity,

Δqx

 is the original demand of commodity X,

Δqx

 is the change in demand of X,

Δpy

 is the original price of commodity Y, and

Δpy

 is the change in price of Y.

Solved Questions on Elasticity of Demand

Q1.  The price elasticity of demand is defined as the responsiveness of :

a. price to a change in quantity demanded.

b. quantity demanded to a change in price.

c. price to a change in income.

d. quantity demanded to a change in income.

Answer: By definition, The elasticity of demand is the change in demand due to the change in one or more of
the variable factors that it depends on. Therefore, options a and c are incorrect, since they talk about the
responsiveness of a price.

The responsiveness of the quantity demanded to the change in income is called Income elasticity of demand
while that to the price is called Price elasticity of demand. Therefore, the correct answer is option B.

Q2: The price of a commodity decreases from Rs.6 to Rs. 4. This results in an increase in the quantity
demanded from 10 units to 15 units. Find the coefficient of price elasticity.

Ans: The Coefficient of price elasticity $$= E_p = \frac{\Delta q}{\Delta p} \times \frac{p}{q}$$

Where, q is quantity, p is price and Δ is the change.

Therefore, we have
 Δq=15–10=5

Δp=6–4=2
Hence,

=Ep=52×610=1.5
Price Elasticity of Demand
Economists define elasticity of demand as to how reactive the demand for a product is to changes in factors
such as price or income. Let us learn more about the price elasticity of demand. However, before we go
further, let us briefly revisit the laws of supply and demand.

Laws of Demand and Supply

The law of demand states that all conditions being equal, as the price of a product increases, the demand for
that product will decrease. Consequently, as the price of a product decreases, the demand for that product will
increase. Therefore, the law of demand defines an inverse relationship between the price and quantity factors
of a product.

The law of supply, on the other hand, states that all factors being constant, an increase in price will cause an
increase in the quantity supplied. That is the quantity being supplied will move in the same direction as the
price. Production units will invest more in production and supply more products for sale at an increased price.
Therefore, the law of supply defines a direct relationship between the price and quantity.

Price Elasticity of Demand

Now as mentioned earlier, the elasticity of demand measures how factors such as price and income affect the
demand for a product. Price elasticity of demand measures how the change in a product’s price affects its
associated demand. Now you can measure the price elasticity of demand (PED) mathematically as follows:

Price Elasticity of Demand (PED) = % change in quantity demanded / % change in price

Next, let us look at how we can measure PED.

Coefficient of Price Elasticity

Economists measure the price elasticity of demand (PED) in coefficients. In response to the change in price,
demand for a product can be elastic, perfectly elastic, inelastic, or perfectly inelastic based on the coefficient.
Now, you need to understand that since price and demand move in opposite directions, the coefficient will
have a negative value. However, in most cases, economists do not use the negative sign and focus on the
coefficient itself. Let us now look at the numerical values of the coefficient of PED.

Perfectly Inelastic (PED = 0)

When the price elasticity of demand or PED is zero, then the demand is perfectly inelastic. That is, there is no
change in the quantity demanded in response to the change in price. The demand curve remains vertical.
Demand is completely unresponsive to the change in price.

Inelastic (PED is between 0 and 1)

If the percentage of change in demand is less than the percentage of change in price, then the demand is
inelastic. For instance, let us say that the price of a chocolate increases from Rs.10 to Rs.20 and the associated
demand decreases from ten chocolates to five chocolates. So now the PED will be 50% divided by 100%,
which is 0.5. Hence, the demand here is inelastic.

Elastic or Unit Elastic (PED = 1)

When the percentage of change in demand is the same as the percentage of change in price, then the demand
is unit elastic. For example, let us say that the price of a candy drops from Rs.10 to Rs.5 and the demand
increases from 10 candies to 15 candies. Here, the percentage of change in demand is equal to the percentage
of change in price (50% divided by 50%, which is 1).
Perfectly Elastic (PED > 1)

If the percentage of change in demand is more than the percentage of change in price, then the demand is
perfectly elastic. For instance, if a 10% increase in price causes a 20% drop in demand, then the coefficient of
PED is 3, which means that the demand is perfectly elastic.

Factors that affect Price Elasticity

Now that you are familiar with the coefficient of the price elasticity of demand, let us understand the factors
that affect the elasticity of demand.

1] Number of Substitutes Available

If there are several substitutes or brands available for a product, then the elasticity of demand for the product
will be high because consumers can shift from one brand to another depending on the change in price.
Chocolates, for instance, is a good example of substitutes. Consumers can choose between several brands of
chocolates.

2] Price of Product in Relation to Income

Now when a household’s income changes, the demand for goods and services also varies in response to the
income. Hence, the demand for products and services becomes elastic.

3] Cost of Substitution

In some cases, the result of changing from one brand to another may be quite high. For instance, if a certain
cable service has a lock-in period of deposit, then an existing consumer cannot change to another service,
although inexpensive, without losing the deposit. Hence, the demand becomes inelastic.

4] Brand Loyalty

Sometimes, consumers are loyal to a specific product. In such cases, the price change in that product will not
affect its associated demand. Brand loyalty, therefore, makes the demand inelastic.

5] Necessary Goods

Necessary goods such as medicines and petrol usually have an inelastic demand. As consumers have to
purchase these goods irrespective of the change in price, the demand remains unresponsive.

Solved Example on Price Elasticity of Demand

Q: How does price elasticity affect firms and industries?

In addition to consumers, the price elasticity of demand also affects industries and firms. By studying how
consumers react to PED, they can understand how to price their products to ensure competitiveness. By
understanding PED, they can invest in effective sales forecasting and manage revenue and profits.
Understanding PED also helps industries to manage their advertising strategies.

Income Elasticity of Demand

Often, when you get a bonus at work or a raise, your first instinct is to celebrate by buying something
expensive or pampering yourself and your family. But have you ever wondered how your sudden shopping
spree might affect the demand for some products? In this article, we will discuss the concept of income
elasticity of demand.

Income Elasticity of Demand

The elasticity of demand measures how factors such as price and income affect the demand for a product.
The income elasticity of demand measures how the change in a consumer’s income affects the demand for a
specific product. You can express the income elasticity of demand mathematically as follows:

Income Elasticity of Demand (YED) = % change in quantity demanded / % change in income

The higher the income elasticity of demand for a specific product, the more responsive it becomes the change
in consumers’ income.

Now, we can measure the income elasticity of demand for different products by categorizing them as inferior
goods and normal goods. The income elasticity of demand for a particular product can be negative or
positive, or even unresponsive.

Normal Goods and Luxuries

The income elasticity of demand for a product can elastic or inelastic based on its category—whether it is an
inferior good or a normal good. Now, the coefficient for measuring income elasticity is YED.

When YED is more than zero, the product is income-elastic. Normal goods have positive YED. That is, when
the consumers’ income increases, the demand for these goods also increases.

However, normal goods can further be broken down into normal necessities and normal luxuries. Normal
necessities have a positive but low income-elasticity compared to luxurious goods.

The income elasticity coefficient or YED for normal necessities is between 0 and 1. Normal necessities
include basic needs such as milk, fuel, or medicines.

Factors such as a change in price or change in consumers’ income do not affect the demand for necessary
goods. The percentage of change in the demand for these products is less in proportion to the percentage of
change in consumers’ income.
Luxuries, on the other hand, are highly income-elastic. Examples of luxury goods include high-end
electronics or jewellery. For instance, if a consumer’s income increases, he/she may invest or purchase a
high-end mobile or an HD television.

The percentage of change in demand is more in proportion to the change in income. However, it is important
to note that the concept of luxury is contextual and it depends on the circumstances of consumers.

Inferior Goods

Inferior goods have a negative income elasticity; that is YED is less than 0. If the consumers’ income
increases, they demand less of these goods. Inferior goods are called inferior because they usually have
superior alternatives.

For instance, if a consumer’s income increases, then he/she might start taking a cab instead of opting for
public transport. Public transport, in this case, is an inferior good.

Usually, when the economic growth is good and there is an increase in consumers’ income, the demand for
inferior goods reduces and there is an inward swing of the demand curve.

Consequently, when the incomes reduce and price of goods increases because of recession, then the demand
for inferior goods increases, thereby causing an outward swing of the demand curve.

Solved Example on Income Elasticity of Demand

Q: What is the importance of income elasticity of demand?

Ans: Measuring the income elasticity of demand is important for industries and business units as they can
then forecast how the demand for their products may change in response to consumer incomes.

As luxury goods are more income-elastic, manufacturers of luxury goods can change their marketing and
advertising strategies based on the change in consumers’ income. Measuring the income elasticity can also
help businesses to predict the sales cycles of their goods and services.

Cross Elasticity of Demand

Have you noticed how a change in the price of petrol affects the demand for automobiles that run on diesel?
Have you ever wondered why the consumption of tea increases when there is an increase in the price of
coffee? Now, let us familiarize ourselves with Cross Elasticity of Demand.

Economists define elasticity of demand as to how reactive the demand for a product is to changes in factors
such as price or income. However, the elasticity of demand does not just stop there. There are times when the
price change of one product affects the demand for another product. And this concept is called cross-elasticity
of demand, which we will discuss in this article. However, before we go further, let us briefly revisit the laws
of supply and demand.

Laws of Demand and Supply

The law of demand states that all conditions being equal, as the price of a product increases, the demand for
that product will decrease. Consequently, as the price of a product decreases, the demand for that product will
increase. Therefore, the law of demand defines an inverse relationship between the price and quantity factors
of a product.

The law of supply, on the other hand, states that all factors being constant, an increase in price will cause an
increase in the quantity supplied. That is quantity and price moves in the same direction. Production units
will invest more in production and supply more products for sale at an increased price. Therefore, the law of
supply defines a direct relationship between price and quantity.

Cross Elasticity of Demand

Now, in economic terms, cross elasticity of demand is the responsiveness of demand for a product in relation
to the change in the price of another related product. The relevant word here is “related” product. Unrelated
products have zero elasticity of demand. An increase in the price of pulses will have no effect on the demand
for chocolates. You can measure the cross elasticity of demand by dividing the percentage of change in the
demand for one product by the percentage of change in the price of another product.

Cross Elasticity of Demand = % of the change in the demand for Product A / % of the change in the price of
product B

The most important concept to understand in terms of cross elasticity is the type of related product. The cross
elasticity of demand depends on whether the related product is a substitute product or a complementary
product.

Substitute and Complementary Products

As mentioned earlier, cross elasticity measures the demand responsiveness in relation to related products.
And these related products can be either substitutes or complementary products. Let us understand the
difference between the two.

Substitute Products

Substitute products are goods that are in direct competition. An increase in the price of one product will lead
to an increase in demand for the competing product. For instance, an increase in the price of petrol will
force consumers to go for diesel and increase the demand for diesel. Now, the cross elasticity value for two
substitute goods is always positive. The more close the substitutes are in terms of use and quality, the more
positive the cross elasticity of demand would be. That is, even a minor change in the price of one product
highly affects the demand for the substitute product.
However, if the related product is a weak substitute, then the demand will be less cross elastic, but positive.
That is, a change in the price of a product might not greatly affect the demand for its substitute.

Substitute products have a positive cross elasticity of demand. As the price

for Y increases, the demand for substitute X also increases.

Complementary Products

Complementary goods, on the other hand, are products that are in demand together. An ideal example would
be coffee beans and coffee paper filters. If the price of coffee increases, then the demand for filters would
reduce because the demand for coffee will reduce. The cross elasticity of demand for two complementary
products is always negative.

Again, the stronger the complementary relationship between two products, the more negative the cross
elasticity coefficient would be. For instance, if the price of XBOX increases, the demand for XBOX
compatible games would reduce.

Products that complement each other show a negative cross elasticity

of demand. As the price of Y rises, the demand for X falls.

Solved Question on Cross Elasticity of Demand

Q: What is the relevance of Cross Elasticity of Demand?

Ans: Cross elasticity of demand is an important and relevant concept for industries and production units.
Research analysts in a company closely analyze the cross elasticity trends in the market between related
products and then set prices for their products.

A company can sell its premium product at a higher price if it has no substitutes. However, if a product has a
strong substitute available in the market, then the company will strategically market and price that product to
ensure a steady demand.

Movement along the Demand Curve and Shift of the Demand Curve
While understanding the meaning and analysis of a demand curve in the study of Economics, it is also
important to be able to make a distinction between the movement and shift of the demand curve. In this
article, we will look at ways by which you can understand the difference between a movement along a
demand curve and shift of the demand curve.

Movement along the Demand Curve and Shift of the Demand Curve

Every firm faces a certain demand curve for the goods it supplies. There are many factors that affect the
demand and these effects can be seen by observing the changes in the demand curve. Broadly speaking, the
factors can be categorized into two types:

Movement of the Demand Curve

When there is a change in the quantity demanded of a particular commodity, because of a change in price,
with other factors remaining constant, there is a movement of the quantity demanded along the same curve.

The important aspect to remember is that other factors like the consumer’s income and tastes along with the
prices of other goods, etc. remain constant and only the price of the commodity changes.

In such a scenario, the change in price affects the quantity demanded but the demand follows the same curve
as before the price changes. This is Movement of the Demand Curve. The movement can occur either in an
upward or downward direction along the demand curve.

We know that if all other factors remain constant, then an increase in the price of a commodity decreases its
demand. Also, a decrease in the price increases the demand. So, what happens to the demand curve?
In Fig. 1 above, we can see that when the price of a commodity is OP, its demand is OM (provided other
factors are constant). Now, let’s look at the effect of an increase and decrease in price on the demand:

 When the price increases from OP to OP”, the quantity demanded falls to OL. Also, the demand curve
moves UPWARD.

 When the price decreases from OP to OP’, the quantity demanded rises to ON. Also, the demand
curve moves DOWNWARD.
Therefore, we can see that a change in price, with other factors remaining constant moves the demand curve
either up or down.

The shift of the Demand Curve

When there is a change in the quantity demanded of a particular commodity, at each possible price, due to a
change in one or more other factors, the demand curve shifts. The important aspect to remember is that other
factors like the consumer’s income and tastes along with the prices of other goods, etc., which were expected
to remain constant, changed.

In such a scenario, the change in price, along with a change in one/more other factors, affects the quantity
demanded. Therefore, the demand follows a different curve for every price change.

This is the Shift of the Demand Curve. The demand curve can shift either to the left or the right, depending
on the factors affecting it.

Let’s look at an example which captures the effect of a change in consumer’s income on the quantity
demanded.
 Quantity demanded when the average Quantity demanded when the average
Price (Rs.)
household income is Rs. 4000 household income is Rs. 5000

5 10 (A) 15 (A1)

4 15 (B) 20 (B1)

3 20 (C) 25 (C1)

2 35 (D) 40 (D1)

1 60 (E) 65 (E1)

The demanded quantities are plotted as demand curves DD and D’D’ as shown below:
From Fig. 2 above, we can clearly see that if the income changes, then a change in price shifts the demand
curve. In this case, the shift is to the right which indicates that there is an increase in the desire to purchase the
commodity at all prices.

Hence, we can conclude that with an increase in income the demand curve shifts to the right. On the other
hand, if the income falls, then the demand curve will shift to the left decreasing the desire to purchase the
commodity.

Solved Question on a shift of the demand curve

Q1. In the case of movement of the demand curve, it:

a. moves upward or downward

b. moves left or right

c. both of the above

d. none of the above

Answer: Movement of the demand curve happens when all other factors affecting the quantity demanded,
remain constant and only the price changes. Hence, the demand moves upward or downward along the same
curve. Therefore, the correct answer is option A.

Exceptions to the Law of Demand

We all know that supply and demand factors influence the market conditions of an economy and determine
the prices of goods and services. In a competitive market, the price conditions of a product or service will
keep varying until the demand equals the supply thereby creating an equilibrium. Let us look at
some exceptions to this law of demand like Giffen goods, necessary goods, etc.

Law of Demand

Now the law of demand states that all conditions being equal, as the price of a product increases, the demand
for that product will decrease. Consequently, as the price of a product decreases, the demand for that product
will increase. For instance, a consumer may buy two dozens of bananas if the price is Rs.50.

However, if the price increases to Rs.70, then the same consumer may restrict the purchase to one dozen.
Hence, the demand for the bananas, in this case, was reduced by one dozen. Therefore, the law of demand
defines an inverse relationship between the price and quantity factors of a product.

The graph shows the demand curve shifts from D1 to D2, thereby demonstrating the inverse relationship between the price of a product and the quantity
demanded.

Exceptions to the Law of Demand

Note that the law of demand holds true in most cases. The price keeps fluctuating until an equilibrium is
created. However, there are some exceptions to the law of demand. These include the Giffen goods, Veblen
goods, possible price changes, and essential goods. Let us discuss these exceptions in detail.

Giffen Goods

Giffen Goods is a concept that was introduced by Sir Robert Giffen. These goods are goods that are inferior
in comparison to luxury goods. However, the unique characteristic of Giffen goods is that as its price
increases, the demand also increases. And this feature is what makes it an exception to the law of demand.
The Irish Potato Famine is a classic example of the Giffen goods concept. Potato is a staple in the Irish diet.
During the potato famine, when the price of potatoes increased, people spent less on luxury foods such as
meat and bought more potatoes to stick to their diet. So as the price of potatoes increased, so did the demand,
which is a complete reversal of the law of demand.

Veblen Goods

The second exception to the law of demand is the concept of Veblen goods. Veblen Goods is a concept that is
named after the economist Thorstein Veblen, who introduced the theory of “conspicuous consumption“.
According to Veblen, there are certain goods that become more valuable as their price increases. If a product
is expensive, then its value and utility are perceived to be more, and hence the demand for that product
increases.

And this happens mostly with precious metals and stones such as gold and diamonds and luxury cars such as
Rolls-Royce. As the price of these goods increases, their demand also increases because these products then
become a status symbol.

The expectation of Price Change

In addition to Giffen and Veblen goods, another exception to the law of demand is the expectation of price
change. There are times when the price of a product increases and market conditions are such that the product
may get more expensive. In such cases, consumers may buy more of these products before the price increases
any further. Consequently, when the price drops or may be expected to drop further, consumers might
postpone the purchase to avail the benefits of a lower price.

For instance, in recent times, the price of onions had increased to quite an extent. Consumers started buying
and storing more onions fearing further price rise, which resulted in increased demand.

There are also times when consumers may buy and store commodities due to a fear of shortage. Therefore,
even if the price of a product increases, its associated demand may also increase as the product may be taken
off the shelf or it might cease to exist in the market.

Necessary Goods and Services

Another exception to the law of demand is necessary or basic goods. People will continue to buy necessities
such as medicines or basic staples such as sugar or salt even if the price increases. The prices of these
products do not affect their associated demand.

Change in Income

Sometimes the demand for a product may change according to the change in income. If a household’s income
increases, they may purchase more products irrespective of the increase in their price, thereby increasing the
demand for the product. Similarly, they might postpone buying a product even if its price reduces if their
income has reduced. Hence, change in a consumer’s income pattern may also be an exception to the law of
demand.
Solved Example for You

Q: Which of the following is a Veblen Good?

a. Potatoes

b. Salt

c. Luxury Car

d. None of the above

Ans: The correct answer is C. A luxury car is a Veblen good. They are expensive products whose value
increases if the price is higher. More expensive the product, the higher its value.