Elasticity of demand the concept

Elasticity of demand refers to the responsiveness of change in quantity demanded

because of change in any of the factors affecting quantity demanded.

The more popular types of elasticity of demand are w.r.t. price, income, and cross
(related goods) elasticity of demand.

Price Elasticity
Methods of calculating Price elasticity of demand
1.

Percentage Method:
(% change in Qty demanded)

Ep =

_________________________
(% change in price)

Types of Price Elasticity of Demand

Elastic

Demand (Ep > 1): When % Change in Quantity

Demanded > % Change in Price

Unit

Elastic Demand (Ep = 1): When % Change in

Quantity Demanded = % Change in Price

Inelastic

Demand (Ep < 1): When % Change in Quantity

Demanded < % Change in Price

Perfectly

Elastic Demand (Ep = ): When Quantity

Demanded Changes by a very large percentage in
response to an almost zero Change in Price

Perfectly

Inelastic Demand (Ep = 0): When the Quantity

Demanded remains constant as Price changes

2. Point Method: Used

when the price change is very small;

Here, price elasticity of demand at any given point on the
demand curve is equal to the lower segment divided by
the upper segment.

E p = Lower segment of demand curve

Upper segment of demand curve

Elasticity Along a Demand Curve

Ed =

Price

Ed > 1

Elasticity declines along

demand curve as we move
toward the quantity axis
Ed = 1
Ed < 1
Ed = 0

Quantity

Methods of Measuring Price elasticity

3. Arc Method: Used when the price change is relatively
large; i.e where we want to calculate elasticity over an
arc (a segment) of the demand curve.

X X

P P

4) Total expenditure (outlay) method

It is often useful to know what happens to total
expenditure made by the consumer on a good when its
price changes.
Total expenditure = (Price) x (Qty. purchased)
Price
change

E(p) > 1

E(p) < 1

Price falls

T.E increases T.E

decreases

Price rises

T.E
decreases

E(p) = 1
T.E remains
constant

T.E increases T.E remains

constant

Determinants of the Price Elasticity of Demand

Availability
Nature of

and proximity of substitutes

commodity

Alternative

uses of the commodity

Proportion

of consumers income spent on the

commodity
Time

available

Cross Elasticity of Demand

xy

p e rc e n ta g e c h a n g e in q u a n tity o f X d e m a n d e d
p e rc e n ta g e c h a n g e in p ric e o f Y

Classification of Goods According to Cross Elasticity

Responsiveness
Cross Elasticity
Type of Good
Exy > 0

Substitutes

Py Qx

Exy < 0

Complements

Py Qx

Income Elasticity of Demand

A measure of the extent to which the demand for a good changes when
income changes, ceteris paribus.
Ey = % Change in Quantity Demanded

% Change in Income

Positive (Ey < 1 or Zero): for necessities

Positive (Ey > 1): Normal goods & luxuries
Ey is Negative for inferior goods

Significance of
Price Elasticity of Demand

Profit maximization requires that business sets a

price that will maximize the firms profit.

Elasticity tells the firm how much control it has over

using price to raise profits.

If Ep > 1, then the % Change in Qd is greater than

% change is price, in such a case the firm (seller)
would have lesser control over selling price (even if
cost of production rises). Because any increase in
price will reduce total revenue. And vice-versa also,
i.e. a decrease in price will increase total revenues.