Elasticity of Demand Overview

Elasticity of Demand

• Elasticity measures how much one variable changes in response to a change in another. It shows responsiveness.
• In demand, elasticity shows how sensitive demand for a product is to changes in its determinants, like price or income.
• Economists examine two main types:
  • Price Elasticity of Demand (PED)
  • Income Elasticity of Demand (YED)

Price Elasticity of Demand (PED)

• Definition: Measures how much the quantity demanded of a product changes when its price changes.
• Formula: PED = (percentage change in quantity demanded) / (percentage change in price)
• Example: If a price drops 10% and demand increases 15%, PED is -1.5 (usually reported as 1.5 to show the magnitude).
• Ranges:
  • Perfectly Inelastic Demand (PED = 0): Quantity demanded doesn't change with price changes.
  • Perfectly Elastic Demand (PED = ∞): Any price increase results in demand dropping to zero.
  • Inelastic Demand (0 < PED < 1): Demand changes less than proportionally to price changes.
  • Elastic Demand (PED > 1): Demand changes more than proportionally to price changes.
  • Unit Elastic Demand (PED = 1): Demand changes exactly in proportion to price changes.

Determinants of PED

• Substitutes: Availability of close substitutes affects price elasticity greatly. If consumers can easily switch to a different product, demand is more elastic. Conversely, few substitutes result in inelastic demand.
• Price: Higher-priced products tend to have more elastic demand, while lower-priced products tend to have inelastic demand. Consumers tend to be more sensitive with higher priced products
• Proportion of Income: If a product takes a large portion of income, consumers are more sensitive to price changes, making demand more elastic. Conversely, small part of income leads to inelastic demand.