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:
1. 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.
2. 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.
Price elasticity of demand
 Price elasticity of demand means degree of responsiveness of demand
for a commodity to the change in its price. For example, if demand for
a commodity rises by 10% due to 5% fall in its price.
Degrees of Price Elasticity of
Demand
Perfectly elastic demand (ed = ∞):When there
is an infinite demand at a particular price and
demand becomes zero with a slight rise in
price, then demand for such a commodity is
said to be perfectly elastic.Graphically, the
demand curve is parallel to X-axis.It is an
imaginary situation.
Perfectly inelastic demand (ed = 0) - The demand
for a commodity is called perfectly inelastic when
quantity demanded does not change at all in
response to change in its prices.Ex –Salt,Insulin,
Fresh water during a
drought,Rare medicines
More than unit elastic demand( Highly Elastic) (ed >1):
When the percentage change in quantity demanded of a
commodity is more than the percentage change in its
price, the demand for the commodity is highly elastic.
This demand curve is flatter .Ex – AC’s , Smart TV’s
Less than unit elastic demand (ed < 1) : The
demand for a commodity is called less than unit
elastic or relatively inelastic when the
percentage change in quantity demanded is
less than the percentage change in price of the
commodity. Ex – Petrol and Vegetables. This
demand curve is stepper.
Unit elastic demand (ed = 1):When percentage
change in quantity demanded of a commodity
equals percentage change in its price, the
demand for the commodity is called unit elastic.
Demand curve
is rectangular hyperbola
Percentage Method for Measuring
Price Elasticity of Demand
 This method was introduced by Prof.Marshall . It is also known as
‘Flux Method’ or ‘Proportionate Method’ or ‘Mathematical Method’.
 According to this method, elasticity is measured as the ratio of
percentage change in the quantity demanded to percentage change
in price.
Calculate price elasticity of demand
if demand increases from 4 units to
5 units due to fall in price from Rs
10 to Rs 8.
The demand for a good falls to
240 units in response to rise in
price by Rs 2. If the original
demand was 300 units at the
price of Rs 20, calculate price
elasticity of demand.
Arc Method
 Arc Elasticity measures elasticity at the central point of an arc
between a pair of two points on the demand curve ,instead of a
single point. In finer terms, with the help of the arc method, we
can compute elasticity over a range of prices.
 Arc price elasticity of demand tends to measure the
responsiveness of the quantity demanded in relation to the
price of the product.
 In the above given figure , DD is the demand curve for
the good. R1 (p1, q1) and R2 (p2, q2) are any two p
points on DD. Initially, at the point R1, when the price is
p1, demand is q1. Now if the price decreases by a
considerable amount from p1 to p2, the demand for the
good increases from q1to q2 at the point R2. The
elasticity of demand that is obtained in the case of this
price change is called the arc-elasticity of demand—
here over the arc R1R2 of the demand curve. It should
be remembered here that if our initial point is R2 (p2,
q2) and if, after a rise in price from p2 to p1, come to
the point R1 (p1, q1), then the arc-elasticity of demand
—now over the arc R2R1 is obtained. Since the two
arcs, viz., R1R2 and R2R1, over the demand curve are
identical, the arc-elasticities in these two cases would
also be the same.
• The mid point of Q = (80+88)/2 = 84
• The mid-point of P =(10+14)/2 =12
• % change in Q = 88-80/84 = -0.09524
• % change in price = (14-10)/12 =
0.3333
• PED = -0.09524 /0.3333 = -0.28571
Income Elasticity of Demand
 Income elasticity of demand or YED is
referred to as the corresponding change in
the demand of a product in response to the
change in a consumer’s income. It can also
be defined as the ratio of change in the
quantity demanded by the change in the
customer’s income.
Categories of Income Elasticity
of Demand
 Positive Income Elasticity of Demand
 Negative Income Elasticity of Demand
 Zero Income Elasticity of Demand
Positive Income Elasticity of
Demand
This scenario occurs when the demand for a product increases as
consumer income rises and vice versa. Products that exhibit this
characteristic are called normal goods.
 Negative Income Elasticity of
 Demand
As the consumer income rises, the demand for a particular
commodity drops and increases when income decreases.
 Products that display this behavior are called inferior goods. For
instance, with rising incomes, consumers might reduce their
consumption of millet in favor of wheat, considering wheat as a
superior alternative.
Zero Income Elasticity of
Demand
This relates to products whose demand remains unchanged
regardless of changes in consumer income. Such products are often
labeled as essential goods.
 An example would be salt, where both high-income and low-income
consumers would have a similar consumption level.
Factors Affecting Income Elasticity of
Demand
Income of consumers in a country - In any country, the income level of consumers
is not the same. Therefore, consumers spend on the basis of not only on their need but
also their purchasing capacity. The purchasing capacity of consumers increases with a
rise in their income.

 Nature of products The nature of products being consumed by consumers also has an
important influence on income elasticity. For example, basic goods used on a day to
day basis, such as salt, sugar, and cooking oil, is elastic. Even with a rise in the income
of a consumer, the demand for such products does not change and remain inelastic.

 Consumption pattern With a rise in income, people quickly change their consumption
patterns. For example, people may start buying high priced products with an increase in
their income. This leads to an increase in the demand for the products in the market.
However, once the consumption pattern is established, it becomes difficult to lower the
demand in case of a decrease in income. For example, a consumer may buy a two-
wheeler that runs on petrol as a result of a rise in his/her income. However, over a
period of time, in case his/her income falls, it will be difficult for him to reduce the
consumption of petrol.
Cross Elasticity of Demand
 The Cross elasticity of Demand is the measure of responsiveness of
demand for a commodity to the changes in the price of its substitutes
and complementary goods. For example, change in the price of tea
ordinarily causes change in demand for coffee. Likewise, change in
the price of cars causes change in demand for petrol.
 Degree of Cross Elasticity of Demand
 Positive When goods are substitutes of each other, then a given
percentage rise in the price of good will lead to a given percentage
increase in the demand for the other good. In other words , cross
elasticity of demand is positive in case of substitutes. For example, rise
in the price of coffee will lead to increase in demand for tea, because
the two are close substitutes of each other.
Negative Cross Elasticity
 Negative In case of complementary goods , percentage rise in the
price of one leads to percentage fall in the demand of the other.
Consequently, cross elasticity of demand is negative and the same is
indicated by putting a minus ( -) sign before the number of cross
elasticity of demand.
Zero cross elasticity of demand
 Zero cross elasticity of demand Cross elasticity of demand is zero when
two goods are not related to each other. For example rise in the price of
wheat will have no effect on the demand for shoes. Their cross elasticity
of demand will be called zero.
Advertisement or Promotional
Elasticity
 Advertisement or Promotional Elasticity of Sales The expansion
of demand by means of advertisement and other promotional
efforts may be measured by advertising elasticity of demand
also called promotional elasticity. The concept of
advertisement elasticity is useful in determining the optimum
level of advertisement expenditure. The promotional elasticity
measures the responsiveness of demand to changes in
advertising or other promotional expenses.
 Factors affecting Advertising
Elasticity
The level of total sales - In the initial stages of sale of a
product, particularly of one which is newly introduced in the
market, the advertisement elasticity is greater than unity. As
sales increase, the elasticity decreases. For instance after the
potential market is supplied, the function of advertisement is to
create additional demand by attracting more consumers to the
product, particularly those who are slow in adjusting their
consumption expenditure to provide for new commodities.
Therefore, demand decreases at the rate lower than the rate of
increase in advertisement expenditure.
 Cumulative affect of past advertisement In case
expenditure incurred on advertisement in the initial stages is not
adequate enough to be effective, elasticity may be very low
 Income of the people of the region (state of economy): Expensive advertising
may not yield very good results if the region has been recently hit by an
economic crisis where people have been laid off on a large scale and are
struggling to make ends meet; or in a region with generally low income.
 Price of the product: No matter how much money is put in the advertising, if a
similar product is in the market for a lower price that may take away from the
success of the advertising.
 Brand Awareness: Advertising elasticity is affected by the level of brand
awareness among consumers. brands that are well known and have a strong
reputation tend to have higher advertising elasticity than those that are less
established. For example, a new brand of soft drink may need to invest heavily
in advertising to raise awareness among consumers and generate interest in
their product.
 Product Differentiation: Advertising elasticity is also affected by the degree of
product differentiation. Products that are highly differentiated from their
competitors tend to have higher advertising elasticity than those that are similar
to other products in the market. For example, a luxury car brand may have
more success with advertising campaigns that focus on the unique features of
their vehicles rather than just promoting the brand.
 Advertising Saturation: Advertising elasticity is also affected by the level of
advertising saturation in the market. When there is a high level of advertising for
a particular product or service, consumers may become immune to advertising
messages, leading to a decrease in advertising elasticity. For example, if there
are too many advertisements for a particular type of smartphone..
 Quality/Appeal of the ad: High expense doesn’t always mean high quality in
terms of audio-visual or content. Or the ad just may lack appeal for the
demographic the product is for.
 Use of Price Elasticity of Demand
 Determination of Output Level: For making production profitable, it is essential
that the quantity of goods and services should be produced corresponding to the
demand for that product. Since the changes in demand is due to the change in price,
the knowledge of elasticity of demand is necessary for determining the output level.
 Price Determination :A businessman has to consider the elasticity of demand of that
product. Knowledge of elasticity of demand may help the businessman to make a
decision whether to cut or increase the price of his product or to shift the burden of
any additional cost of production on to the consumers by charging high price.
 Note: In imperfect competition, for items having inelastic demand, the producer will
fix a higher price and items whose demand is elastic the businessman will fix a lower
price.
 Pricing of factors of production."If the demand for factors of production are more
inelastic, the producers are prepare to pay more price for these factors. Likewise, if
the demand for the factors of production is more elastic, the producers are prepared
to pay fewer prices for the factors. For example, if the demand for labour in an
industry is inelastic, the labour unions can easily increase wages. But if demand is
elastic, the wages cannot be raised too much
 Price discrimination : The policy of price discrimination is profitable
to the monopolist when elasticity of demand for his product is
different in different sub-markets. Those consumers whose demand is
inelastic can be charged a higher price than those with more elastic
demand.
 Shifting of tax burden :. If the demand is inelastic the larger part
of the indirect tax can be shifted upon buyers by increasing price. On
the other hand if the demand is elastic than the burden of tax will be
more on the producer.
 Taxation policy The government can impose higher taxes and
collect more revenue if the demand for the commodity on which a tax
is to be levied is inelastic. On the other hand, in ease of a commodity
with elastic demand high tax rates may fail to bring in the required
revenue for the government.
 Designing of Marketing policies and strategies Super Markets is
a market where in a variety of goods are sold by a single
organization. These items are generally of mass consumption.
Therefore, the organization is supposed to sell commodities at lower
prices than charged by shopkeepers in the other bazars. Thus, the
policy adopted is to charge a slightly lower price for items whose
demand is relatively elastic and the costs are covered by increased
sales.
 Public Utilities - The nationalization of public utility services can
also be justified with the help of elasticity of demand. Demand for
public utilities such as electricity, water supply, post and telegraph,
public transportation etc. is generally inelastic in nature. If the
operation of such utilities is left in the hand of private individuals,
they may exploit the consumers by charging high prices. Therefore, in
the interest of general public, the government owns and runs such
services.
 Explanation of paradox of poverty :This paradox is easily explained by
the inelastic nature of demand for most farm products. Since the
demand is inelastic, prices of farm products fall sharply as a result of
large increase in their supply in the year of bumper crops. Due to
sharp fall in prices, the farmers get less income even by selling larger
quantity. This paradox of poverty is the basis of regulation and control
of farm products prices. Government fixes the minimum prices of
farm products because the demand for farm products is inelastic.
Thus, the concept of elasticity of demand helps the government in
determining its agricultural policies.