ELASTICITY OF DEMAND

Topic 4
Dr Nandita Mishra
What is Price Elasticity

Price elasticity of demand is a measure of the responsiveness

of consumers to a change in a product's cost. The more general
term demand elasticity measures the impact of a change in any
of a variety of factors including the product’s price

The formula for any calculation of demand elasticity is the percentage

of change in the quantity that is in demand divided by the percentage
change in the economic variable. So, if the price elasticity of demand
is being measured, the formula would be the percentage of change in
the quantity in demand divided by the percentage change in price.
 • Price elasticity of demand is an
indicator of the impact of a price
change, up or down, on a product's
sales.
• Demand elasticity is a more general
term, allowing the impact on
Key Points demand of a number of factors to
be estimated.
• Higher price elasticity of demand
suggests that consumers are more
responsive to a product's price
change.
Contd..

• Like demand elasticity for any factor, price elasticity of demand is

typically measured in absolute terms.
• If the price elasticity of demand is greater than 1, it is elastic. That is,
demand for the product is sensitive to an increase in price. A price
increase for a fancy cut of steak, for example, may make many
customers choose hamburger instead. A bargain price for the fancy cut
will lead many customers to upgrade to the fancy cut.
Contd

• Price elasticity of demand that is less than 1 is inelastic. Demand for the
product does not change significantly after a price increase. For
example, a consumer either needs a can of motor oil or doesn't need it.
A price change will have little or no effect on demand. But not many will
stock up on motor oil if its price decreases.
• Demand is said to be "unit elastic" when it equals 1. That means that
demand for the product will move proportionately with the price
change. If a candy bar's price increases 5% then 5% of its regular buyers
will switch to another brand.
Contd

• Price elasticity of demand is one of the most common factors calculated

by businesses.
• Most businesses collect data on the impact of price changes in their
industries and use it to calibrate their prices and maximize their profits.
In advance of price changes, knowing the price elasticity of demand
helps them set production levels correctly.
contd
• Another type of demand elasticity is cross-elasticity of demand, which
is calculated by taking the percent change in the quantity that is in
demand for a product and dividing it by the percentage change of the
price for another product. This type of elasticity indicates how
demand for a product responds to price changes for other products.
Explanation

• Suppose that a soft drink company calculates that the demand for a
bottle of its soda increases from 100 to 110 after the price is cut from $2
to $1.50. The price elasticity of demand is calculated as the percentage
change in quantity demanded (110 - 100 / 100 = 10%) divided by a
percentage change in price ($2 - $1.50 / $2). The price elasticity of
demand, in this case, is 0.4. Since the result is less than 1, it is inelastic.
The change ad little impact on the quantity demanded.
Elasticity vs. Inelasticity of Demand

• Inelasticity and elasticity of demand refer to the degree to which

demand responds to a change in another economic factor. Elasticity of
demand measures how demand changes when other economic factors
change. When a change in demand is unrelated to an economic factor, it
is called inelasticity. Price is the most common economic factor used
when determining elasticity or inelasticity. Other factors include income
level and substitute availability
• It is calculated by dividing the percentage change in quantity
demanded by the percentage change in price. If the elasticity quotient is
greater than or equal to one, the demand is considered to be elastic. A
common example of an elastic product is gasoline. As the price of gas
increases and falls with the international market, the demand (the
distance driven by the population) rises and falls in near direct
correlation. Gasoline has an elasticity quotient of one or greater and has
a flatter slope on a graph.
Inelastic

• An inelastic product is defined as one where a change in the price of the

product does not significantly impact the demand for that product.
When demand for a good or service is static when its price or other
factor changes, it is said to be inelastic. So when the price goes up,
consumers will not change their buying habits. The same applies when
the price goes down. Inelastic products are necessities and, usually, do
not have substitutes. So if there is a 1 percent change in the price of a
good, then the amount demanded or supplied will have less than a 1
percent change.
Explanation

• Since the quantity demanded is the same regardless of the price, the demand curve for a
perfectly inelastic good is graphed out as a vertical line. However, there are no clear examples
of a perfectly inelastic good. If this were the case, prices would skyrocket, with no change in
demand. But there are some products that come close. If the elasticity quotient is less than
one, the demand is considered to be inelastic.
• The most common goods with inelastic demand are food, prescription drugs, and tobacco
products. Another common example of a product with inelastic demand is salt. The human
body requires a specific amount of salt per pound of body weight. Too much or too little salt
could cause illness or even death. Therefore, the demand for salt changes very little with the
price. Salt has an elasticity quotient that is close to zero and a steep slope on a graph.
Perfectly Elastic
Demand

• Most rational individuals would not

decide to pay more for a Bumpy Ride
flight. Given the variety of airlines to
choose from and the identical value
propositions, demand is said to be
perfectly elastic in this scenario the
quantity demanded of airplane tickets
from Bumpy Ride will drop down to
zero with an increase in price.
Economists call this perfectly elastic
demand.
Relatively Elastic Demand
• Relatively elastic demand means
that the quantity demanded of a
good or service will be impacted
by a price change in that good or
service. Typically, a good or
service is said to have high price
elasticity when many substitutes
for that good exists.
Relatively Inelastic Demand
• Tne example of a good that is
considered relatively price
inelastic is gasoline. Businesses
and consumers both require gas
to thrive in this economy.
Despite the movement towards
alternative fuels, many people
who are dependent upon
gasoline in their daily lives and
are neither likely nor capable of
switching to alternative fuels as
a practical substitute.
Perfectly Inelastic Demand
• With the change in price there is
no change in Quantity
Demanded
Elastic Demand

• Proportionate change in
quantity demanded due to
proportionate change in price
Formula

• Proportionate change in Q 2 ---- Q 1 / Q1

Quantity Demanded / -----------------------------------------------
Proportionate Change in Price P2 -------- P 1 / P 1