Elasticity of Demand

Prepared by
Farzana Yeasmin
Assistant Professor
Department of Agricultural Economics
Faculty of Agricultural Economics & Rural Sociology
Bangladesh Agricultural University,Mymensingh-2202
 Meaning of Elasticity of Demand

• Elasticity of demand
We know that there is a close relationship between price and demand. When price
rises, demand contracts and when price falls demand extends. This extension and
contraction which takes place in demand as a result of change in price is called
elasticity of demand.

The law of demand only states the direction of change of demand caused by the
change in price. This does not tell us by how much or to what extent the quantity
demanded of a good will change in response to a change in its price.

This information as to how much or to what extent the quantity demanded of a good
will change in response to a change in its price is provided by the concept of elasticity
of demand.
 Various concepts of Demand Elasticity

Individual’s demand for a good depends upon the price of the good, income of the
individual, and the prices of related goods. It can be put in the following functional
form:

Dx =f (Px, I, Py, Pz etc.) Where Dx stands for the demand for good X, Px stands for Price
of good X, I for individual’s income, Py , Pz etc. for the prices of related goods.

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, income or prices of related
goods.
 Various concepts of Demand Elasticity

Accordingly, there are three kinds of demand elasticity: price elasticity, income
elasticity, and cross elasticity.

1. Price elasticity: Price elasticity of demand relates to the responsiveness of quantity

demanded of a good to the change in its price.

2. Income elasticity: Income elasticity of demand refers to the sensitiveness of

quantity demanded of a good to the change in income.

3. Cross elasticity: Cross elasticity of demand means the degree of responsiveness of

quantity demanded for a good to a change in the price of a related good, which
may be either a substitute or a complementary with it.
 Methods of Measuring Price Elasticity of Demand

• 1. Percentage Method

• 2. Total Expenditure Method/ Total outlay method

• 3. Geometric Method or Point method

 PRICE ELASTICITY OF DEMAND (Percentage Method)

Price elasticity: Price elasticity of demand expresses to the response of quantity demanded of a good to
the change in its price, given the consumer’s income; his tastes and prices of all other goods.
In other words, Price elasticity can be precisely defined as the proportionate change in quantity
demanded in response to a proportionate change in price. Thus,

Price Elasticity

𝐶h𝑎𝑛𝑔𝑒 𝑖𝑛𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑/𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑

¿
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐h𝑎𝑛𝑔𝑒𝑖𝑛𝑝𝑟𝑖𝑐𝑒/ 𝑃𝑟𝑖𝑐𝑒
 PRICE ELASTICITY OF DEMAND

Or, in symbolic terms

Where, stands for price elasticity
q stands for quantity demanded
÷ p stands for price
Δ stands for infinitesimal change
=×

=×

Mathematically speaking, price elasticity of demand () is negative, since the change in quantity
demanded is in opposite direction to the change in price. When price falls, quantity demanded
rises and vice versa. But for the sake of convenience in understanding the magnitude of response
of quantity demanded to the change in price we ignore the negative sign and take into account
only the numerical value of the elasticity.
Problem: Price Elasticity of Demand

1. Suppose the price of a commodity falls from Tk. 10 to

Tk. 9 per unit and due to this, quantity demanded of
the commodity increases from 100 unit to 120 unit.
Find out the price elasticity of demand.
Solution: Price Elasticity of Demand
Here/Given that,
Original/Initial price of the commodity, = Tk.10
New price of the commodity, = Tk.9

Original/Initial quantity demanded of the commodity, = 100 unit

New quantity demanded of the commodity, = 120 unit

Now, Change in price, Δp=

=TK.(9-10)
= Tk. -1
Change in quantity demanded of the commodity, Δq=
= (120-100)unit
=20unit
Price elasticity of demand, =?
 Solution: Price Elasticity of Demand
We know that, Where,
Initial price, p= = Tk. 10
× Change in price, Δp= Tk. -1
= × Initial quantity demanded, q = = 100
unit
= -2 Change in quantity demanded, Δq= 20
unit

Comment: If the price of a commodity falls/decreases by

1%, then quantity demanded of that commodity will
rise/increase by 2%. Here, 2 (ignoring ‘-’ sign) which is
greater than unity (or 1). So, the demand is said to be
elastic.
 Price elasticity (Total Expenditure or Total Outlay
Method)

• Under this method, we measure elasticity of demand by examining the change

in the total expenditure due to a change in price.
• Prof. Alfred Marshall evolved the total outlay, or total revenue or total ex­
penditure method as a measure of elasticity. By comparing the total expenditure
of a purchaser both before and after the change in price, it can be known
whether his demand for a good is elastic, unity or less elastic.
• Total outlay is price multiplied by the quantity of a good purchased: Total Outlay
= Price x Quantity Demanded.
Price elasticity (Total Expenditure or Total Outlay Method)

• In this connection, Marshall has given the following propositions:

• A) Relatively elastic demand (Ed >1): When with a given change in
the price of a commodity total outlay increases, elasticity of demand
is greater than one.
• B) Unitary elastic demand (Ed = 1): When price falls or rises, total
outlay does not change or remains constant, elasticity of demand is
equal to one.
• C) Relatively inelastic demand (Ed <1): When with a given change in
price of a commodity total outlay decreases, elasticity of demand is
less than one.
Price elasticity (Total Expenditure or Total Outlay Method)
This can be expalined with the help of following example:

This can be explained with the help of the following example.

 Measurement of Elasticity at a Point on the Demand Curve (Geometric method or
point method)
Let a straight-line demand curve DD' be given and it is required to measure elasticity at point R on this curve. In
figure(a) corresponding to point R on the demand curve DD' price is OP and quantity demanded at it is OQ. With a
small fall in price from OP to OP' , quantity demanded increases from OQ to OQ' .

Price Elasticity

Using symbols,

=×

= × ……………(i)
Measurement of Elasticity at a Point on the Demand
Curve
 Measurement of Elasticity at a Point on the Demand Curve

In figure(a) when price falls from OP to OP' , quantity demanded increases from OQ to OQ' . This
change in price by PP' causes change in quantity demanded (ΔQ) by QQ' . Substituting these in (i)
above, we get

× ……………(i)

Or,
=×

Since in Fig. (a) QQ' = MR' and PP' = RM and OP= QR

……………(ii)

Therefore,
 Measurement of Elasticity at a Point on the Demand Curve

Now taking triangles RMR’ and RQD’ in Fig. (a)

˂ MR’R= <QD’R (corresponding <s)

< RMR’= <RQD’ (right<s)

Third <MRR’ is common to both of the triangles.
Therefore, triangles RMR’ and RQD’ are similar. A property of similar triangles is that
their corresponding sides are proportional to each other.
From this it follows that, =
 Measurement of Elasticity at a Point on the Demand Curve

Writing in place of in equation (ii), we have

……………(i)]

……………(iii)
 Measurement of Elasticity at a Point on the Demand Curve

Now, the triangles QD’R and PDR are similar as their corresponding angles are equal. Therefore we
have
𝑄𝐷 ′ 𝑃 𝑅
=
𝑅𝐷 ′ 𝑅𝐷

𝑄𝐷 ′ 𝑅𝐷 ′
Or, =
𝑃𝑅 𝑅𝐷
It will be seen from fig. (a) PR=OQ. Thus substituting OQ for PR in the equation above, we get

Or, …………(iv)
 Measurement of Elasticity at a Point on the Demand Curve

Now, from equation (iii) & (iv), we can write it as,

𝑄𝐷 ′ 𝑅𝐷 ′
𝑒𝑝 = =
𝑂𝑄 𝑅𝐷

Hence from above we find that price elasticity at point R on the straight line demand
curve is,
𝑅𝐷 ′ Lower segment
𝑒𝑝 = =
𝑅𝐷 Upper segment
Point method of measuring price elasticity of demand
• The general formula for measuring price elasticity of demand
at a point is Lower segment (of the demand curve )
¿
Upper segment ( of the demand curve )
• at point ‘A’
That means =α (perfectly elastic)
• at point ‘M’
Where MB> AM, Hence, >1 (relatively elastic)
• at point ‘P’
Where PB=AP, Hence, =1 (Unit elasticity)
• at point ‘N’
Where NB<AN, Hence, <1 (relatively inelastic)
• at point ‘B’
That means =0 (perfectly Inelastic)
 Five cases/degrees of Price elasticity
(i) Perfectly elastic or infinite elasticity

(ii) Perfectly inelastic or zero elasticity

(iii) Relatively inelastic

(iv) Relatively elastic ; and

(v) Unit elasticity

 Perfectly elastic or infinite elasticity
• Figure 1 shows an infinitely elastic demand curve DD, which is a horizontal straight
line parallel to the axis of X. It shows that even an infinitesimally small reduction in
price leads to an unlimited extension of demand.
 Perfectly inelastic or zero elasticity
• Figure 2 shows perfectly inelastic demand or zero elasticity.
• The demand curve DD/ is a vertical straight line perpendicular to the axis of X and
parallel to the axis Y. It shows that however, much of the price may fall or rise, the
amount demanded remains the same.
 Relative inelastic

Figure 3 shows less elastic demand commonly referred to as inelastic demand.

 Relatively Elastic
In figure 4, the area OM/P/N/is greater than the area OMPN and, therefore, the
elasticity is more than unity.
 Unit elasticity
In figure 5, the two areas are the same i.e. the total amount spent on the purchases
of the commodity at different prices is same. Thus, the elasticity of demand in this
case is unity. Such a curve is called an equilateral or rectangular hyperbola.
 Problem: Income Elasticity of Demand

1. If consumer’s income rises from Tk. 300 to Tk. 320,

his purchase of the good X increases from 25 unit per
week to 30 unit. Find out the income elasticity of
demand.
 Solution: Income Elasticity of Demand
Here/Given that,
Primary income of the consumer, = Tk.300
New income of the consumer, = Tk.320

Now, Change in income, Δy=

=TK.(320-300)
= Tk. 20
Initial quantity demanded of good X, = 25 unit
New quantity demanded of good X, = 30 unit
Change in quantity demanded, Δq=
= (30-25)unit
= 5 unit
Income elasticity of demand, =?
 Solution: Income Elasticity of Demand
We know that,
Where,
× Initial income of the consumer, y= = Tk. 300
= × Change in income of the consumer, Δy= Tk. 20
Initial quantity demanded, q = = 30 unit
=3 Change in quantity demanded, Δq= 5 unit

Comment: If the income of a consumer increases by 1%, then

quantity demanded of commodity X will also increase by 3%. Here,
3 which is greater than unity (or 1). So, the demand is said to be
elastic.
 Problem: Cross Elasticity of Demand

1. If the price of coffee rises from Tk. 4.50 per unit

to Tk. 5 per unit and as a result the quantity
demanded of tea of a consumer increases from 60
unit to 70 unit. What will be the cross elasticity of
demand?
 Solution: Cross Elasticity of Demand
Given that,
Price of coffee, Now,
= Tk.4.50 per unit Change in price, Δp=
New price of coffee, =TK.(5-4.5)
= Tk.5 per unit = Tk. 0.5
Change in quantity demanded,
Initial quantity demanded of tea, Δq=
= 60 unit
= (70-60)unit
= 10unit
New quantity demanded of tea,
= 70 unit Cross elasticity of demand, =?
 Solution: Cross Elasticity of Demand
We know that, Where,
× Initial price of coffee, = = Tk. 4.50
Change in the price of coffee, = Tk. .5
= × Initial quantity demanded of tea, = = 60 unit
= 1.50 Change in quantity demanded of tea, = 10 unit

Comment: If the price of coffee rises by 1%, then quantity

demanded of tea will also rise by 1.50%. Here, 1.50 and
the result is positive. So, the demand is said to be elastic
and coffee & tea are substitute goods.
 Elastic and inelastic demand
• The change in demand is not always in proportion to change in
price.

• A small change in price may lead to a great change in demand. In

that case, we shall say that the demand is elastic or sensitive or
responsive.

• A big change in price is followed only by a small change in demand,

it is said to be a case of inelastic demand.

• For example, even if the price of salt varies widely, we continue to

buy almost the same quantity, the demand is inelastic. But, if the
price of radio set falls, many people who couldn’t afford to buy
before, may now be introduced to buy; the demand will then
stretch or expand; it is elastic.
 Elastic and inelastic demand
• The elastic demand is said to be greater than
unity (or one) and inelastic demand less than
unity (but not less than zero).

• It is unity or one when the percentage change

in price results in an exactly compensating
percentage change in the quantity demanded.
References

• Ahuja, H.L. (1977). Advanced Economic Theory, S. Chand & Company

Ltd., Ram Nagar, New Delhi- 110055

• Dewett, K.K. (2005). Modern Economic Theory, S. Chand & Company

Ltd., Ram Nagar, New Delhi- 110055

• Mankiew, N.G. (2004). Principle of Economics (3rd ed., Mason OH:

Thomson/ South-Western,). ISBN: 0-324-20309-8.
THANKS TO ALL