ELASTICITY OF DEMAND
Elasticity
Elasticity is the measure of the extent to which a variable reacts in response to the change in
another variable, most commonly this sensitivity is the change in price relative to the
changes in other variables. In business and economics, elasticity refers to the degree to
which individuals, consumers or producers change their demand or the amount supplied in
response to price or income changes. It is mainly used to identify how consumers’ demand
change in response to change in a good or service’s price.
Concepts of Elasticity of Demand
The up and down movement of price of goods indicates the movement of goods’ quality and
that how customers react to the products/goods they purchase; this explains the law of
demand. However, it does not tell us about the demanded quantity of goods and how much
the demand will change regarding to the price change in goods. That is where the concept of
Elasticity of demand grew.
Contribution of Alfred Marshall
Alfred Marshall gave this law to economics. Elasticity of demand refers to the price
elasticity of demand. Marshall was the first one to define price elasticity of demand, which
predicts how a demand changes after the change on price. In theory, we usually observe that
the demand of a product decreases after the increase in price. However, Marshall noted that
this behavior is not always true and the price of some goods increases without a reduction in
the demand. It has raised lot of debits in many schools of thoughts and has been important
for the formation of economic theories regarding responsiveness of the demand of quantity
of goods by consumers with respect to the change in price.
According to Marshall, ‘The elasticity of demand in a market is great or small as the amount
demanded increases much or little for a given fall in price and diminish much or little for a
given rise in price’. He distinguished five degrees of elasticity, which are elastic, highly
elastic, absolutely elastic, less elastic or inelastic, depending on the elasticity of demand,
which is determined by various factors such as its price, incomes of the people, prices of
correlated goods, substitutes, time element, taste and habit [ CITATION Kir \l 1033 ]. The demand is
elastic if the change in prices affect demand whereas inelastic when demand is invariant after
the change in price. Demand for luxuries are highly elastic, for comfort elastic and for
necessities like food and medication inelastic. Any change in the size of the determinants of
demand will consequently cause change in the quality demanded for a certain good. The
level of responsiveness of amount of requested products suggests an adjustment in its value
or price, salary and costs of related merchandise. Marshall argued that supply and demand,
costs of production, and price elasticity all work in coordination.
Types of Elasticity of Demand
There are three types of elasticity of demand; price elasticity, income elasticity and cross
elasticity.
1. Price Elasticity
It is an economic measure of the change in the quantity demanded of a product in
relation to its price change. Mathematically, it is expressed as:
% change∈quantity demanded
Price Elasticity of Demand=
% change∈ price
In order to understand the working of the real economy, economists use price
elasticity to have an idea how the supply or demand alternates with respect to the price
changes. The more easily a shopper can replace / substitute a product with rising
substitute, the more elastic it will be. As we know that coffee and tea are good
substitutes of each other, either of the two products can easily substitute other when
the increase in the price of one product occurs[ CITATION Exp \l 1033 ]. The following
coefficients describe the value of price elasticity of demand (ped):
i. If Ped = zero, demand is perfectly inelastic i.e. the demand does not change at
all after the change in price. The demand curve will be vertical.
ii. If Ped lies between zero and one, the demand is inelastic that is the percent in
the demanded quantity is smaller than the percent change in price.
iii. If ped = 1, the demand is unit elastic i.e. the change in the demanded quantity is
the same as the change in the price of the good.
iv. If ped > 1, the demand is elastic and the demand of quantity is proportionally
greater than the change in price[ CITATION Wll18 \l 1033 ].
2. Income Elasticity
Income elasticity of demand refers to the sensitivity of the demanded quantity with
respect to the change in incomes, provided all other variables constant.
Mathematically,
% change∈the quality demanded
Income Elasticity=
% change∈income
With income elasticity of demand, we can differentiate a product as necessity or
luxury.
3. Cross Elasticity
Cross Elasticity of demand is an economic measure of the responsiveness of the
demand of quantity of one good when the price for another good changes. We also call
it cross-price elasticity of demand. It is measured by;
% change∈the demanded quantity of one good
Cross Elasticity=
% change∈the price of another good
Two products, which are substitutes of each other, will have a positive cross elasticity
while the ones which are supplements of each other, will have a negative cross
elasticity.
Importance of Elasticity of Demand
We saw different concepts of elasticity of demand but most important of them is Price
Elasticity of Demand. It is very helpful in making decisions regarding business, and at
organization, governmental and international level. Following aspects visualize its
importance:
1. International Trade
It is important to know about the elasticity of demand of goods to fix the price before
exporting them. The international bodies that trade with other companies and countries
fix higher prices for the products having inelastic products. However, if the demand is
elastic in the importing country, then they will have to lower the prices.
2. Formulation of Government Policies
The price of elasticity of demand plays an important role to formulate government
policies especially taxation policy. The goods with inelastic demand tend to have higher
taxes while the goods with the elastic demands will have imposition of lower taxes.
3. Factor Pricing
The companies use price elasticity of demand concept for the determination of prices for
the production factors. Share of each factor in the national product is determined with
respect to its demand in production activity. A factor with an inelastic demand will attract
more rewards than other factors.
4. Decision of Monopolist
Before fixing the price of a product, monopolists consider the nature of the demand in
order to know when to increase or decrease the price of a good. Monopolists also use
price discrimination policy for the same goods in different market, depending on the
demand of the product in the respective markets.
5. Paradox of poverty amidst plenty
Inelastic demand relates to this concept. This happens with the product of high supplies
due to uncalculated production. This cause a decrease in the prices of those products and
at the end revenue falls too[ CITATION Cha1 \l 1033 ].
Conclusion
Particularly speaking, the concept and knowledge of price elasticity of demand applies
to so many circumstances of life and work. This knowledge is a need for all firms in
the production process in order to know exactly when to increase or decrease the price
of the goods in the market to increase the market’s competitiveness.
Works Cited
Chand, S. (n.d.). The Importance of Elasticity of Demand (5 Important Points). Your Article Library.
Retrieved from http://www.yourarticlelibrary.com/economics/the-importance-of-elasticity-
of-demand-5-important-points/8964
Explaining Price Elasticity of Demand. (n.d.). Retrieved from
https://www.tutor2u.net/economics/reference/price-elasticity-of-demand
Kenton,W. (2018, October 22). Price Elasticity of Demand. Retrieved from
https://www.investopedia.com/terms/p/priceelasticity.asp
Shaile, K. (n.d.). Top 14 Contributions of Alfred Marshall to Economics. Economics Discussion.
Retrieved from http://www.economicsdiscussion.net/economics-2/alfred-marshall/top-14-
contributions-of-alfred-marshall-to-economics/21044
