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Content page
Elasticity of demand……………………………………………………………....1

1. Price elasticity of demand (Ed)……………………………………………1

Degrees of price elasticity of demand…………………………………………….2

Determinants of elasticity…………………………………………………………3

2. Income elasticity of demand………………………………………………4

Types of goods…………………………………………………………………….5

i. Normal good
ii. Inferior good
3. Cross elasticity of demand………………………………………………..6

References
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Elasticity of demand
Elasticity of demand measures the degree to which demand for a good or service varies with its
price. Normally, sales increase with fall in prices and decrease with rise in prices. Elasticity of
demand also called price demand elasticity.

Price elasticity of demand (Ed):

Price elasticity of demand is the quantitative measure of consumer behavior that indicates the
quantity of demand of a product or service depending on its increase or decrease in price. Price
elasticity of demand can be calculated by the percent change in the quantity demanded by the
percent change in price.

Percentage change∈quantity of demand

Ep=
Percentage change∈ price

(Q 1 – Q 2)
(Q 1+Q 2)
Ep=
( P 1 – P 2)
(P 1+ P 2)

The price elasticity of demand is always negative due to the inverse relationship between the
price and quantity demanded. But we ignore the negative sign and take into account only the
numerical value of the price elasticity of demand.

Degrees of price elasticity of demand:

If the formula creates the number equal to1, elasticity of demand is unitary. In other words,
quantity changes at the same rate as price.

For example, 10% change in price causes 10% change in demand. E p =1 ,Fig (a) shows unitary
elastic demand curve.

If the number greater than 1, the demand is elastic. In other words, quantity changes faster than
price. For example, if 10% change in price results, 20% change in quantity demanded. E p =2 Fig
(b) is representing elastic demand curve.
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If the number is less than 1, demand is inelastic. In other words, quantity changes slower than
price. For example, when 20% change in price causes 10% change in demand. Fig (c) is
representing inelastic demand curve. There are two extreme cases of perfectly inelastic and
perfectly elastic demand shows perfectly inelastic demand as shown. Fig. d, fig. e. When the
demand for a commodity does not change despite change in price, the demand is said to be
perfectly inelastic.

Demand is said to be perfectly elastic if small change in price would lead to infinite change in
the quantity demanded.

Determinants of elasticity:

Elasticity of demand of all goods are not equal. It is different for different goods. even for one
good, the elasticity changes with time, place, income, tastes etc. thus there is no hard and fast
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rule as to which commodity has elastic demand and which has however the following general
rule can help us to decide whether the demand will be elastic or inelastic.

1. Demand for necessary and convention necessaries will be inelastic. This is due to the fact
that people must buy which such goods whether price is high or low.
2. Demand for luxuries is elastic. People can easily live without such goods.
3. Goods having many uses have elastic demand. If their prices increases, these may not be
used for less important purposes. E.g. Electricity is used for lighting, heating, cooking
and motive power.
4. Proportion of income spent. A good taking a very small part of our budget has inelastic
demand. E.g. demand for safety matches is inelastic.
5. Demand for goods having many close substitutes will be elastic.
6. Price of a commodity itself is important factor in determining its elasticity of demand.
Too cheaper good or too dearer goods have inelastic demand e.g salt and diamonds.
7. Jointly demanded goods have less elastic demand because a fall or rise in their price will
not affect their demand much unless the price of complements also change e.g. demand
for petrol and automobiles. Or bat and ball.
8. Fashion and habit: if some commodity comes into fashion, its demand becomes less
elastic. Then people become careless about its price because they take it as a necessity.

Income elasticity of demand:

Income is one of the determinate of demand. So, the concept of income elasticity is used to
measure the effect of changes in income of the consumers on the demand for a commodity. It is
defined as,

The income elasticity of demand is the rate of responsiveness of demand to change in the income
of the consumer.

Percentage change∈quantity of demand

Ey ¿
Percentage change ∈income

∆q ∆ y ∆q y
E y= ÷ = ×
q y q ∆y
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Types of goods

Normal good:

A normal good is any good that increases in demand when income increases.

Example:

Monthly income of consumer (Rs) Monthly demand for meat (kg)

5000 4
8000 5
∆q ∆ y ∆q y
E y= ÷ = ×
q y q ∆y

1 3000 1 5000 5
E y= ÷ = × =
4 5000 5 3000 12

Inferior good:

An inferior good is a type of good that decreases in demand when income rises. Conversely,
demand for these goods will increase when income falls. In case of inferior goods the income
elasticity is negative.

Example:

Y(Rs) Demand for pulses(kg)

5000 4
9000 3

∆q ∆ y ∆q y
E y= ÷ = ×
q y q ∆y

−1 4000 −1 5000 −5
E y= ÷ = × =
4 5000 4 4000 16
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Cross elasticity of demand:

The change in price of the commodity does not only affect its own demand but also the demands
for many related commodity. For example meat and fish are substitutes. A change in price of
meat will affect demand for fish. Similarly, bat and ball are complements. A rise or fall in price
for balls will lead to change in demand for bats. To measure this cross effect of price variation,
the concept of cross elasticity is used.

The rate of responsiveness of quantity demanded of commodity A to changes in price of

commodity B.

To measure cross elasticity for change in price of B and quantity of A, we use the rule.

% change∈quantity demanded of A
CE AB=
% change∈ price of B

∆ QA ∆ PB
CE AB= ÷
QA PB

Example:

Price of wheat (Rs/mound) PB Quantity demanded of rice (mound) Q A

200 1000
300 1200

Here,

PB =¿Price of wheat = 200

∆ P B= change in price = 300

Q A = Quantity demanded of rice = 1000

∆ Q A = change in quantity = 1200

∆ QA ∆ PB
CE AB= ÷
QA PB

200 100 200 200 2

÷ = × =
1000 200 1000 100 5
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Rise is a substitute for wheat, so CE AB of demand for rice has a positive value. I.e. if price of
wheat rises, people increase the consumption of rice.

In case of complement commodities the value of cross elasticity will come out to be negative.

References:

Books:
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Fundamentals of economics part 1 by Habib Ullah Vaseer 2002-2003

Websites:

http://www.businessdictionary.com/definition/elasticity-of-demand.html

http://study.com/academy/lesson/the-elasticity-of-demand-definition-formula-
examples.html

http://www.economicsdiscussion.net/elasticity-of-demand/5-types-of-price-
elasticity-of-demand-explained/3509

http://www.economicsdiscussion.net/elasticity-of-demand/elasticity-of-demand-
meaning-and-types-of-elasticity-explained-with-dia

http://www.investopedia.com/terms/i/incomeelasticityofdemand.asp