Elasticity of Demand

Elasticity: Basic concept

• Elasticity is the “Responsiveness” of one variable to the change of another variable.
• It refers to how much change takes place in one variable in response to the change in
another variable.
• “Sensitivity” is the word that is often used as synonym to Elasticity

Elasticity of demand
• Elasticity of demand refers to the proportionate change in the quantity demanded of a
product in response to the change in price
• Elasticity of demand denotes the degree of change in the quantity demanded of a
product as a result of change in its price

Types of Elasticity
• Price Elasticity: Refers to the proportionate change in the quantity demanded with the
change of price
• Income elasticity: Refers to the responsiveness of quantity demanded with the change in
consumers’ income holding the price of the goods constant.
• Cross elasticity: Refers to the change of the quantity demanded of one product in
response to the change of price of another product

Measurement of Elasticity

Price elasticity % response of quantity

─────────────
%change in price
Cross elasticity - % response of quantity
complements ─────────────
%change in complement
Cross elasticity -
substitutes % response of quantity
─────────────
%change in substitute
Income elasticity % response of quantity
─────────────
%change in income
Exchange rate elasticity % response of quantity
─────────────
%change in exchange rate
Measurement Measurement of Elasticity
Point Elasticity

Q1 – Q0
───────
Q0
Elasticity =──────────────
P1 – P0
───────
P0
Arc Elasticity

Q1 – Q0
───────
(Q0+Q1)/2
Elasticity =──────────────
P1 – P0
───────
(P0+P1)/2

Price, Income and Quantity Demanded

Year Price of Quantity of Real Income Price of Price of

Butter Butter Margarine Jelly
1 0.95 200 11000 0.65 2.00

2 1.10 180 11000 0.65 2.30

3 1.10 210 11000 0.90 2.30

Price elasticity
Period 1-1
180-200
───────
200
Price elasticity=──────────
11-0.95
───────
0.95

-0.100
=───────
0.157

= 0.633
Income elasticity
Period 2-3
210-180
───────
180
Income elasticity=──────────
11500-11000
───────
11000

= 3.66

Cross elasticity substitute

Period 2-3
210-180
───────
180
Cross elasticity=──────────
0.9-0.65
───────
0.65

= 0.433

Cross elasticity compliments

Period 2-3
210-180
───────
180
Cross elasticity(substitute)=──────────
2.3-2.0
───────
2.0

= -0.66

Summary
price incime substitute compliments

%change in Q 0.10 0.167 0.167 -0.100

% change in Dep.Variable 0.158 0.045 0.385 0.150

elasticity -0.633 3.667 0.433 -0.667

Butter
Q1 – Q0
───────
Q0
Point Price Elasticity =──────────────
P1 – P0
───────
P0
Between the Years Point elasticity estimate
1-2 price -0.63
2-3 income 3.66
2-3 Cross substitute 0.43
1-2 Cross complements 0.66

Elastic and Inelastic Demand

When change in quantity demanded is relatively higher than the change of price, it is
called Elastic Demand
On the other hand, quantity demanded changes at a smaller proportion than the Price,
it’s called Inelastic Demand

Infinite Elasticity and Zero Elasticity

When a small change in the price result in an unlimited change in the quantity
demanded i.e when a small reduction of price of a certain product causes unlimited
increase in its demand or vice versa, the demand for the product can be said to have
Infinite elasticity.
When change in the price results in no change in the quantity demanded, it is called
Zero Elasticity