Elasticity of Demand

What is Elasticity of Demand?

The elasticity of demand is an economic principle that measures the extent of consumer
response to changes in quantity demanded as a result of a price change, as long as all
other factors are equal. In other words, it shows how many products customers are
willing to purchase as the prices of these products increases or decreases.

What Does Elasticity of Demand Mean?

The elasticity of demand formula is calculated by dividing the percentage that quantity
changes by the percentage price changes in a given period.

Where, EP= Price elasticity of demand

q= Original quantity demanded
∆q = Change in quantity demanded
p= Original price
∆p = Change in price

Therefore, the elasticity of demand is the percentage change in the quantity demanded
as a result of a percentage change in the price of a product. Because the demand for
certain products is more responsive to price changes, demand can be elastic or inelastic.
When the demand for a product is elastic, the quality demanded is highly responsive to
price changes. When the demand for a product is inelastic, the quality demanded
responds poorly to price changes. Thus, a change in price will affect an elastic
product’s demand, but it will have little effect on an inelastic product’s demand.

For example, Ram has blue and black pens. If the price of blue pens drops because
consumers are not interested in the color of the pen but in utility, demand will increase
for the black pens for one reason: black and blue pens are perfect substitutes, so either

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can meet consumer needs. However, if the price of blue pencils drops and the quantity
demanded decreases as well, the demand for blue pens is elastic since the quality
demanded is highly responsive to price changes due to the existence of black pens
(perfect substitutes).
Shyam smokes two packages of cigarettes daily and he pays ₹100 per pack. If the price
of cigarettes increases to ₹150 per package, Shyam will have to pay ₹150 daily to
satisfy his need. However, because there are very few substitutes for tobacco, Shyam
will continue to buy his package of cigarettes in spite of the price change. In this case,
demand for tobacco is inelastic because the price change doesn’t really affect the
quality demanded (absence of substitute).

Types of Demand Elasticities

One common type of demand elasticity is the PRICE ELASTICITY of demand, which
shows the responsiveness of the quantity demanded for a good relative to a change in
its price. Firms collect data on price changes and how consumers respond to such
changes. They then later calibrate their prices accordingly to maximize profits.

Another type of demand elasticity is CROSS-ELASTICITY of demand, which is

calculated by taking the percent change in quantity demanded for a good and dividing
it by the percent change of the price for another good. This type of elasticity indicates
how demand for a good reacts to price changes of other goods.

Lastly is INCOME ELASTICITY of demand. Income elasticity of demand refers to the

sensitivity of the quantity demanded for a certain good to a change in real income of
consumers who buy this good, keeping all other things constant. The formula for
calculating income elasticity of demand is the percent change in quantity demanded
divided by the percent change in income. With income elasticity of demand, you can
tell if a particular good represents a necessity or a luxury.

What is the Price Elasticity of Demand?

Price Elasticity of Demand is a macroeconomic term that measures the correlation
between a change in demand and a change in price for a product or service. In other
words, it shows how a change in the price of a product will affect the overall demand
for the product.
Demand for a product can range from elastic to inelastic. Demand is considered more
elastic the more a change in price affects the amount desired. Demand is considered
more inelastic the less a change in price affects the amount desired.
In other words, the more elastic the demand is, the more the price will affect the
demand. For instance, a price increase of an elastic product would decrease the demand

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for it. Inelastic products’ demand, on the other hand, is not affected by price. If the
price were increased on these products, the demand would remain the same.

Elasticity can be perfectly inelastic or perfectly elastic or anywhere in between;

however, the two extremes rarely occur in the real world.

Price elasticity can be divided into 5 types:

1. Perfectly Elastic Demand (EP = ∞)

The demand is said to be perfectly elastic if the quantity demanded increases infinitely
(or by unlimited quantity) with a small fall in price or quantity demanded falls to zero
with a small rise in price. Thus, it is also known as infinite elasticity. It does not have
practical importance as it is rarely found in real life.

In the given figure, price and quantity

demanded are measured along the Y-axis
and X-axis respectively. The demand
curve DD is a horizontal straight line
parallel to the X-axis.
It shows that negligible change in price
causes infinite fall or rise in quantity
demanded.

2. Perfectly Inelastic Demand (EP = 0)

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The demand is said to be perfectly inelastic if the demand remains constant whatever
may be the price (i.e. price may rise or fall). Thus it is also called zero elasticity. It also
does not have practical importance as it is rarely found in real life.

In the given figure, price and quantity

demanded are measured along the Y-axis
and X-axis respectively. The demand
curve DD is a vertical straight line
parallel to the Y-axis. It shows that the
demand remains constant whatever may
be the change in price.

3. Relatively Elastic Demand (EP> 1)

The demand is said to be relatively elastic if the percentage change in demand is greater
than the percentage change in price i.e. if there is a greater change in demand there is a
small change in price. It is also called highly elastic demand or simply elastic demand.
For example:If the price falls by 5% and the demand rises by more than 5% (say 10%),
then it is a case of elastic demand. The demand for luxurious goods such as car,
television, furniture, etc. is considered to be elastic.

In the given figure, price and quantity

demanded are measured along the Y-axis
and X-axis respectively. The demand
curve DD is more flat, which shows that
the demand is elastic. The small fall in
price from OP to OP1 has led to greater
increase in demand from OM to OM1.
Likewise, demand decrease more with
small increase in price.

4. Relatively Inelastic Demand (Ep< 1 )

The demand is said to be relatively inelastic if the percentage change in quantity
demanded is less than the percentage change in price i.e. if there is a small change in
demand with a greater change in price. It is also called less elastic or simply inelastic
demand.For example: when the price falls by 10% and the demand rises by less than

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10% (say 5%), then it is the case of inelastic demand. The demand for goods of daily
consumption such as salt etc. is said to be inelastic.

In the given figure, price and quantity

demanded are measured along the Y-axis
and X-axis respectively. The demand
curve DD is steeper, which shows that
the demand is less elastic.The greater fall
in price from OP to OP1 has led to small
increase in demand from OM to OM1.
Likewise, greater increase in price leads
to small fall in demand.

5. Unitary Elastic Demand ( Ep = 1)

The demand is said to be unitary elastic if the percentage change in quantity demanded
is equal to the percentage change in price. It is also called unitary elasticity. In such
type of demand, 1% change in price leads to exactly 1% change in quantity demanded.
This type of demand is an imaginary one as it is rarely applicable in our practical life.

n the given figure, price and quantity

demanded are measured along Y-axis
and X-axis respectively. The demand
curve DD is a rectangular hyperbola,
which shows that the demand is unitary
elastic. The fall in price from OP to OP1
has caused equal proportionate increase
in demand from OM to OM1. Likewise,
when price increases, the demand
decreases in the same proportion.

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What is Cross Price Elasticity of Demand?
Cross price elasticity of demand, often called cross elasticity, is an economic
measurement that show how the quantity demanded for one good responds when the
price of another good changes. In other words, it answers the question, do more people
demand product A when the price of product B increases?
Example
A complementary good is one that is bought along side of another. For instance, butter
and bread are complements. If the price of butter goes up, the demand for bread will
probably go down due to less people wanting to make sandwiches, all things equal.
Conversely, a substitute good is one that can be exchanged for another. For example,
coffee might be substitute for tea. If the price of tea rises too much, consumers might
choose to purchase coffee instead.
Here are three basic rules of elasticity:
1. Positive; the two goods are substitutes
2. Equal to 0; the two goods are independent of each other
3. Negative; then the two goods are complements

What is Income Elasticity of Demand?

This is an important concept because it shows what consumers and demographics
purchase specific products. For example, luxury goods have a positive correlation
between income and demand meaning the demand for these products increases as
consumer income increases. An example of this might be high-end car.
Inferior goods, on the other hand, have an inverse correlation between income and
demand. As income increases, demand for these products decreases. A good example of
this is public transportation. As consumers’ income increases, they purchase a car and
stop riding the bus.
A normal good has completely constant demand no matter the income level of
consumers. For instance, all people purchase bread and milk regardless of their income.
The income elasticity of demand formula is calculated by dividing the change in
demand by the change in income.
IED = (%change quantity in demanded) / (%change in income)

Types of Income Elasticity of demand

1. Positive income elasticity of demand (E Y>0)

As the income of consumer increases, they consume more of superior (luxurious)
goods. On the contrary, as the income of consumer decreases, they consume less of
luxurious goods.

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2. Negative income elasticity of demand ( EY<0)
If the quantity demanded for a commodity decreases with the rise in income of the
consumer and vice versa, it is said to be negative income elasticity of demand.

3. Zero income elasticity of demand ( EY=0)

If the quantity demanded for a commodity remains constant with any rise or fall in
income of the consumer and, it is said to be zero income elasticity of demand. For
example: In case of basic necessary goods such as salt, kerosene, electricity, etc. there is
zero income elasticity of demand.

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