Elasticity of Demand

Session 3
Elasticity of Demand

1. Own Price elasticity of demand

2. Cross-price elasticity of demand

3. Income elasticity of demand

Elasticity of Demand: Measurement

• Own-Price elasticity of demand: Percentage change

in demand for the percentage change in it’s own
price, keeping other things constant;

% Quantity
Ep 
% Price
 Price Elasticity of Demand: Measurement

• Arc price elasticity of demand: Elasticity is

measured over a stretch of the demand curve;

Q2 Q1 P2  P1
Ep  
(Q1 Q2) / 2 (P1  P2) / 2
Price Elasticity of Demand: Measurement

• point elasticity of demand: Price-elasticity of

demand measured at a point on the demand curve is
known as point elasticity of demand.
Q P1
p  
P Q1
• For a non-liner demand curve;
Ep= dQ/dP * P1/Q1
Price Elasticity of Demand: Nature of good

1. Elastic demand: When Ep > 1 ; Luxury goods.

2. In-elastic demand: When 0 < Ep < 1; Necessary

goods

3. Unitary elasticity of demand : Ep = 1

Check: Flatter (steeper) the demand curve, higher

(lower) is the price elasticity of demand .
Income elasticity of demand: Measurement

• Income elasticity of demand: Percentage change in

demand due to the percentage change in income of
the consumer; keeping other things constant.
 Income elasticity of demand: Nature of good

1. Normal good : When 0 ≤ EY ≤ 1 ; demand of the

commodity increases (decreases) when income of
the consumer increases (decreases).

2. Inferior good : When EY < 0 ; people demand less of

the inferior good when their income increases.
 Cross-price elasticity of demand: Measurement

• Cross-price elasticity of demand: Percentage change in

demand of the commodity for the percentage change in
price of related goods (substitute or complements),
keeping other things constant.
Cross-price elasticity: Substitutes and complements

1. Substitutes : Two goods are said to be substitute if one

can be consumed in place of other. For example tea and
coffee. In case of substitute goods, an increase in price
of one increases the demand for other and hence the sign
of cross-price elasticity is positive.

2. Complements : Two goods are said to be complement

to each other when they are consumed together hence
the sign of cross-price elasticity is negative.
Cross-price elasticity: Examples

1. The cross-elasticity of demand for beef with respect

to pork prices was calculated to be about +0.25.
With respect to prices of chicken, it was about
+0.12. Both numbers indicate that the products are
substitutes.
Price-elasticity of Demand and Revenue: Firm’s
perspective