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3. Elasticity of Demand
Introduction

The law of demand states that when the price of a good falls, its quantity demanded rises and vice
versa. The law of demand only indicates the direction of change in quantity demand in response
to change in price. But the demand theory is silent about the degree of change in price and
quantity demanded. This information as to how much or to what extent the quantity demanded of
a good will change in its price in provided by the concept of price elasticity of demand. The
concept of elasticity of demand therefore refers to the degree of responsiveness of quantity
demanded of a good to a change in its price consumers income and prices of related goods.
Accordingly there are three concepts of demand elasticity; price elasticity, income elasticity and
cross elasticity.

PRICE ELASTICITY OF DEMAND

Price elasticity of demand is defined as the ratio of the percentage change in quantity demanded
of a commodity to a percentage exchange in price. Thus

ep =

ep=

ep=

Q1 : Original quantity demanded before the price change

Q2 : New quantity demanded after the price change
P1 : Original price
P2 : New Price

For an example Let = Q1 = 1500, Q2 = 2000

P1 = 10, P2 = 5
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Ep=

The price elasticity is negative emphasizing the inverse relationship between price and demand.
However in practice the negative sign is omitted and the inverse relationship is implied.

The value of elasticity of demand can be also be found out in other way.

Suppose there is 10 percent increase in prices of apple which caused quantity demanded to fall

by 10%. We can calculate price elasticity of demand for apple as =

But we can take –10 for quantity demanded in spite of plus ten.

So price elasticity of demand is . Thus we get –1 as the price elasticity of demand.

On the other hand it price falls by 10 percent and quantity demanded increase by 10 percent.

Ep =

We are getting the same result.

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Types of price elasticity : Different products react differently to the price change. A price for a
essential product such as salt has little impact on demand while the price change in other product
has huge impact on demand. Price elasticity are generally classified in to the following
categories.
1- Perfectly elasticity demand (ep = )
Perfectly elastic demand is said to happen when a little change in price leads to an infinite change
in quantity demanded. A small rise in price on the other hand reduces the demand to zero. In
such a case the demand curve is horizontal to OX axis as shown in the diagram.

FIGURE 2.1

The fig.2.1 show that at the ruling price OP, the demand is infinite. But in the real world we
don’t find such cases.

Perfectly in elastic demand : In case of perfectly in elastic demand, irrespective of any rise or
fall in price of a commodity, the quantity demanded remains the same. The perfectly inelasticity
of demand is shown in the figure 2.2given below.
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FIGURE 2.2
In the fig.2.2 price is OP the quantity demanded is OQ. If the price falls to OP1, the quantity
demanded remain constant. Similarly if the price rises to OP 2 the demand still remains the same.
This is also an exceptional case.

Unitary Elastic Demand : The demand is said to have unitary elastic when a given proportionate
change in the price level brings about and equal proportionate change in quantity demanded.
The ep = 1.

FIGURE 3.3
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In the fig.2.3 when price is OP the quantity demanded in OQ. Now price falls to OP 1 the quantity
demanded in increases to OQ 1. the change in price is PP 1 and change in quantity demanded is
OQ1 = PP1 = OQ1. The shaded area in both the case is same.

Relatively Elasticity Demand : Relatively elasticity demand is a situation in which a small

change in price leads to a large change in quantity demanded. The elasticity of demand in this
case is greater than one. The demand curve is flatter one. This happen particularly in case of
luxurious commodities.

FIGURE 3.4

The fig.2.4 when the price is OP the quantity demanded in OQ. If the price falls from OP to OP 1,
the quantity demanded increases from OQ 1 to OQ2. Hence the quantity demanded changes more
than the change in price.

Relatively in-elastic demand : Under the relative inelastic demand a given percentage change in
price produces a relatively less percentage change in quantity demanded. In such a case
elastically of demand is said to be less than one. The demand curve is steeper and the
commodities belonging to necessary are perfectly inelastic.
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FIGURE 3.5

In fig.2.5 when price OP the quantity demanded is OQ, when price falls from OP to OP, the
quantity demanded increases from OQ to OQ. Hence the quantity demanded change is less than
the change in price.

Factors determining price elasticity of demand:

(a) Nature of the Product : Whether the demand for a particular product is more elastic or less
elastic it depends upon the nature of the commodities. The demand for product that fall in the
category of necessities are usually inelastic. This is because their demand do not change when
there is a change in price (Food, medicine). On the other hand the demand for luxurious are
elastic where even a small change in price reflects on a huge change in the demand.

(b) Number of users : Elasticity of demand for any commodity depends on the number of users.
Demand is elastic if a commodity has more users and inelastic if it has only one use. As
electricity has multiple users, if its price falls it will be demanded more. But if its price rises
minimum will be demanded for every purpose.

(c) Substitution: When a product has many substitutes than its demand will be relatively elastic.
This is because if the price of a substitute goes down than customers switch to that substitute and
vice versa. Products without substitute has weak substitutes have relatively inelastic demand.
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(d) Postponement of the consumption : The goods and commodities whose consumption can be
postponed are more elastic in nature. For example if the prices of silk rises., its demand will fall
drastically because its consumption can be postponed to the future.

On the other hand the commodities whose consumption can’t be postponed are less elastic. The
use of medicines can’t be put off. Hence the demand for medicine is inelastic.

Income level : People with high income are less affected by price changes. On the other hand
people with low income are highly affected by price rise. People with high income will not
change their buying habits because of the increase in price of either essential commodities or
luxurious while other will cut back on purchase of certain commodities to compensate for the
essential commodities if there is a price increase.

Proportion of income spent : When a person spends only a very small part of his income on
certain product the price change in these products does not materially affect his demand for the
product. Here the demand is inelastic.

Habits: If consumers are habituated of some commodities, the demand for such commodities will
be usually inelastic. It is because that the consumer will use them even their prices goes up.

MEASUREMENT OF ELESATICITY OF DEMAND

Percentage Method : Price elasticity can be precisely measured by dividing the percentage
change in quantity demanded by the percentage change in price that caused it.

Price elasticity =

ep =

ep = price elasticity
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q = original quantity
p = original price
= a small change

Example: The price of a commodity is 150 and its quantity demanded is 50 kg, if its price falls to
100 and quantity demanded increases to 100 kg, calculate elasticity of demand.

P = 150 P1 = 100
Q = 50 Q1 = 100

Ep =

(–) sign is attached because quantity demanded and price are inversely related.

Point Method : We can measure elasticity of demand at any point on a straight line demand
curve. Suppose we want to measure elasticity of demand at price K.

Fig 3.6
At point K, OP is the price and OQ is the quantity demanded. Suppose price falls from OP to OP 1
and the quantity demanded increases from OQ to OQ1.

Price elasticity =
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Ep =

So, ep = ……….eqn.1

In the fig. QQ1 = ML and PP1 = KM. and OP = QK

Therefore ep = …………eqn.2

If we take triangle KML and KQT.

MLK = QTK (corresponding angles)
KML = KQT (right angle)
and MKL is common to both the triangles.

Therefore, triangle KML and KQT are similar. The property of similar triangle is that their
corresponding sides are proportionate to each other.

From this it follows that

If we write in place of

In equation(2) we will get

ep =

ep

Now in the triangle O tT, QK is parallel to Ot

Therefore

So price elasticity of demand at the point

K is =

So, from this formula we can find out elasticity of demand at any point of a straight line demand
curve. This is shown in the diagram given below.
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FIGURE 3.7

In case of a non-linear demand curve to measure the elasticity of demand at any point we have to

draw the tangent to the given point and then finding out the value by . This is

shown in the diagram given below. In the given 2.8

Fig 3.8
DD is the demand curve and we draw a line tT to measure the elasticity of demand. At point K
demand curve DD and tT line touches each other. Therefore both have same slope. So, at point K

elasticity of demand is
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Total expenditure method : According to total expenditure method elasticity of demand can be
measure by considering the change in price and subsequent change in the total quantity of goods
purchased and the total amount of money spent on it.

Total outlay =
There are three possibilities
1. If with a fall in price the total expenditure increases or with a rise in price.. the total
expenditure fall, in that case the elasticity of demand is greater than one.

2. If with a rise or fall in the price demand falls or rises respectively. The total expenditure
remains the same. Ep = 1.

3. If with a fall in price (Demand rises) the total expenditure also falls, and with a rise in price
(Demand falls) the total expenditure also rises the demand is said to be less elastic or elasticity of
demand is less than one. This can be explained with an illustration.

Price Qty demanded Total expenditure Price elasticity

5.00 30 150
4.75 40 190 e>1
4.50 50 225 e>1
4.25 60 255 e>1
4.00 75 300 e>1
3.75 80 300 e=1
3.50 84 294 e<1
3.25 87 282.75 e>1

In the above table we find the price falls from Rs5.00 to Rs.3.25 and the quantity demanded is 87.
we have calculated total outlay by multiplying the quantity demanded with corresponding price.
It is found that price of the commodity falls from Rs.5 to Rs.4.75 from 4.75 to 450 from 4.50 to
4.25 and from 4.25 to Rs.4, the quantity demanded increases so much that total expenditure
increases indicating elasticity of demand is greater than one.
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But when the price falls from Rs.4.00 to Rs.3.75 the total expenditure remain same so the
elasticity of demand is one. After this when Price falls from Rs.3.75 to Rs.3.50 the total
expenditure falls and the elasticity of demand is less than one.

This can be shown in the diagram given below.

In this fig 3.9 the total expenditure has been shown on ex OX is and price on OY axis. Line TT is
the expenditure curve. When the price is OP the total expenditure is OQ 1 but when price falls
from OQ1 to OQ2. the elasticity of demand is greater than one. Suppose the price now falls from
OP1 to OP2 the total expenditure remain same. So elasticity of demand is equal to one. If price fall
from OP2 to OP3 the total expenditure is reduced from OQ2 to OQ. So the elasticity of demand is
less than one.

Numerical Examples:
Q.1. Suppose price of a commodity falls from Rs.10 to Rs.5 per unit. As a result its quantity
demanded increases from 100 units to 150 units. Say whether the demand for goods is
elastic, inelastic or unit elastic.
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Solution : At price 10 the quantity demanded is 100

So the total expenditure = 100 x 10 = Rs.1000
At the price 5, the quantity demanded is 150
= 150 x 10 = 1500

We thus find that change in the price of good the total expenditure of the commodity increase. So
elasticity of demand greater than one.

Q.2. Suppose the price elasticity of commodity x is equal to unity and at Rs.15 per unit the
quantity demanded is 100 unit. How much price of the commodity should be fixed so that
the demand is 80 unit.

Solution : Since the given price elasticity of demand for petrol is equal to unity, the expenditure
on the petrol by individual will remain constant at different prices.
Expenditure = P x Q = 15 x 100 = 1500

Let the higher price of commodity x be ‘P’ the expenditure on the commodity by the consumer so
that the demands 80 units of the commodity
P’ x 80 = Rs.1500
P’ =

Arc elasticity of demand : According to Leftwitch “When elasticity is computed between two
separate points on a demand curve, the concept is called “Arc elasticity”.. This method is other
wise known as “Average elasticity”. In this method we use rather than P. So also we use

in spite of q1.

Arc elasticity of demand =

E=

Q1 = original quantity demanded

Q2 = new quantity demanded
P1 = original price
P2 = new price

OR

Ep =

change in quantity deducted

change in price
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This is shown in the diagram given below

Fig 3.10

In the fig 2.10the quantity is measured on X axis while the price on Y axis. DD is the demand
curve. If we want to measure the arc elasticity between A and B, we have have to take the
average price of OP1 and OP2 as well as quantities Q1 and Q2.

Revenue Method : Mrs. Joan Robinson has given this method she says that elasticity of demand
can be measured with the help of average revenue and marginal revenue.

The formula to measure elasticity of demand is

Ep =

A = average revenue
M = Marginal revenue

INCOME ELASTICITY OF DEMAND

Another important concept of elasticity of demand is income elasticity of demand. Income
elasticity of demand shows the degree of responsiveness of quantity demanded of a good to a
small change in the income of consumers.
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Income elasticity =

ei =

q =quantity demanded
q = change in quantity demanded
Y = income
Y = change in income

Suppose consumer income rises from 100 to 120 his purchase of good X increases from 30 to 40
units, then his income elasticity of demand for X is

ei =

The value of income elasticity is a positive value as there is positive relationship between income
and quantity demanded in case of normal goods

Cross elasticity of demand : It is the ratio proportionate change in the quantity demanded of Y
to a given proportionate change in the price of the related commodity X. It is a measure of
relative change in the quantity demanded of a commodity due to a change in the price of its
substitute.

Co-efficient of cross elasticity demand X for Y =

ec =
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ec stands from cross elasticity of demand X for Y

qx = original quantity demanded of X
qx = changes in quantity demand of good Y
py = stands for original price of good Y.
py = stands for a small change in price of Y.
Numerical example.
You have given the demand function Qx =10 - 6Px +12Py - 4Pz + 10A
Calculate elasticity of demand if price is Rs 800 and quantity demanded is 1200 units.
There is inverse relationship between quantity demanded, So the law of demand states that other

thing remaining constant more is demanded at lower price and less is demanded in at higher

price. Price elasticity of demand shows the degree of responsiveness in change in quantity

demanded due to change in price.

In the above demand function only price will change other factors will remain constant.

Price is = 800
Quantity demanded is 1200
Ed =

Ed =
Ed = -4
The minus sign indicates inverse relationship between price and quantity demanded, so elasticity
of demand is 4.
10. Problem-solving exercises: a) Use the arc-approximation
formula to calculate the price-elasticity of demand coefficient of a firm's product demand
between the (quantity, price) points of (50, $10) and (54, $8). b) Calculate the cross-price
elasticity of demand coefficient of a firm's product X, given that a 10% increase in the price
of its close substitute, product Y, causes the quantity demand of
product X to increase by 15%. c) Calculate the income-elasticity of demand coefficient for a
product for which a 5% increase in consumers' income will increase the quantity demanded
by 4%.

Ans (a)
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Arc elasticity of demand =

= ∆q = 50-54 = - 4
∆p = 10-8 = 2
= = - 0.34

( b)

Cross Elasticity of demand =

= = 1.5

( C) Income elasticity of demand =

= = 0.8

Glossary.
Price Elasticity of Demand. Price elasticity of demand is a measure of the extent to which the
quantity demanded of a good changes when the price of the good changes
Elastic Demand. Demand is elastic if the percentage change in the quantity demanded exceeds
the percentage change in price.
Unit Elastic Demand. If the percentage change in the quantity demanded equals the percentage
change in price
Inelastic demand. If the percentage change in the quantity demanded is less than the percentage
change in price
Perfectly elastic demand. When the quantity demanded changes by a very large percentage in
response to an almost zero percentage change in price.

Perfectly inelastic demand . When the quantity demanded remains constant as the price
changes.
Income Elasticity of Demand. Income elasticity of demand is a measure of the extent to which
the demand for a good changes when income changes, other things remaining the same.
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Cross elasticity of Demand. It is the ratio proportionate change in the quantity demanded of Y to
a given proportionate change in the price of the related commodity X. It is a measure of relative
change in the quantity demanded of a commodity due to a change in the price of its substitute.

SHORT QUESTION
1. What is elasticity of demand ?
2. What is perfectly elasticity of demand ?
3. What is perfectly inelasticity of demand ?
4. What is unitary elasticity of demand ?
5. What is income elasticity of demand ?
6. What do you mean by cross elasticity of demand ?

LONG QUESTIONS
1. What is elasticity of demand ? Explain the factors that determine elasticity of demand.

2. What do you mean by elasticity of demand? How elasticity of demand can be measured
on a point.