Elasticity of Demand: Types and Formulas

Elasticity of Demand Introduction

• Elasticity of Demand is the fourth chapter, taught after Consumer's Equilibrium and Demand.
• The topic of Elasticity of Demand will be covered, and numericals will be covered.
• Elasticity signifies change.
• Elasticity of Demand studies the extent of change in demand relative to price.

Types of Elasticity

• Elasticity includes Price Elasticity, Income Elasticity, and Cross Elasticity.

Price Elasticity

• Price Elasticity is the measurement of change in Quantity Demanded as a result of changing price.

Income Elasticity

• Income Elasticity refers to how much demand fluctuates due to variations in income.

Cross Elasticity

• Cross Elasticity is how changes in demand are influenced by alterations in the price of a Related Good.
• Related Goods are either Complementary or Substitute Goods.
• Example: Demand for tea is affected when coffee prices fluctuate.

Formula for Elasticity of Demand

• Elasticity of Demand (ED) = Percentage Change in Quantity Demanded / Percentage Change in Price.

Calculating Percentage Change

• Percentage Change in Quantity Demanded = (Change in Quantity / Original Quantity) * 100.
• Percentage Change in Price = (Change in Price / Original Price) * 100.
• Delta (Δ) signifies change.
• ΔQ = Q1 - Q (New Quantity - Old Quantity).
• ΔP = P1 - P (New Price - Old Price).

Example Calculation

• Initial Price (P0): Rs. 10, New Price (P1): Rs. 20.
• Initial Demand (QD0): 200, New Demand (Q1): 100.
• ΔQ = 100 - 200 = -100.
• ΔP = 20 - 10 = 10.
• Percentage Change in Quantity Demanded = (-100 / 200) * 100 = -50%.
• Percentage Change in Price = (10 / 10) * 100 = 100%.
• ED = -50% / 100% = -0.5.
• The negative sign indicates the inverse relationship, and does not represent a negative elasticity value.

Degrees of Price Elasticity of Demand

• ED values can be 0, less than 1, 1, greater than 1, or infinite.

ED = 0

• ED = 0 denotes no change in demand even with price alterations, known as perfectly inelastic demand.

ED = Infinite

• ED = Infinite signifies an unlimited demand change from a negligible price change, known as perfectly elastic demand.
• ED = 0 and ED = Infinite are both theoretical scenarios.

ED = 1

• ED = 1 indicates unitary elastic demand, where the percentage change in quantity demanded equals the percentage change in price.
• ED<1 is less elastic demand.
• ED>1 corresponds to highly elastic demand.

Curves of Price Elasticity

• ED = 0: Represented by a vertical straight line, where demand remains constant regardless of price.
• ED = Infinite: Represented by a horizontal straight line, where minor price changes lead to unlimited demand change.
• ED = 1: Represented by a basic downward sloping curve, showing equal changes in price and quantity.
• ED > 1: Represented by a flatter curve, reflecting a larger percentage change in quantity demanded compared to price.
• ED < 1: Represented by a steeper curve, reflecting a smaller percentage change in quantity demanded compared to price.
• The curve flattens as elasticity increases.

Factors Affecting Elasticity of Demand

• Nature of the Commodity: Whether it is a Necessity, Comfort, or Luxury.
• Necessity: Exhibits the least elasticity, with minimal demand change despite price changes (e.g., bread, medicine).
• Comfort: Exhibits elasticity, where demand responds to price changes (e.g., fan, AC).
• Luxury: Exhibits high elasticity, with demand greatly affected by price (e.g., luxury cars, mobile phones).

Availability of Substitutes

• No Substitute (Monopoly): Results in less elasticity, as demand remains relatively constant (e.g., railway).
• With Substitute: Increases elasticity, as demand easily changes (e.g., other forms of transport).

Income Level

• High Income: Leads to less sensitivity to price changes, resulting in less elasticity.
• Low Income: Results in greater sensitivity to price changes, resulting in more elasticity.

Price Level

• Cheap Things: Tend to be less elastic, as small price changes don't greatly affect demand (e.g., matchbox).
• Expensive Things: Tend to be more elastic, as price changes have a greater impact (e.g., Mercedes).

Urgency of Demand

• Can Postpone: Indicates elasticity, as demand can shift depending on circumstances (e.g., cold drink).
• Urgent: Results in inelasticity, as demand remains constant regardless of price (e.g., emergency medicine).

Number of Uses

• Many Uses: Contributes to more elasticity, as demand changes more with price (e.g., milk).
• Few Uses: Leads to less elasticity, as demand changes less with price.

Portion of Total Expenditure

• Small Share: Results in less elasticity, as price changes have little impact (e.g., matchstick).
• Large Share: Increases elasticity, as price changes have a significant impact (e.g., fuel).

Time Period

• Short Time Period: Leads to inelasticity, as demand is less responsive to price changes.
• Long Time Period: Fosters elasticity, as demand can adjust more to price changes.

Habits

• Habitual Items: Tend to be inelastic, as demand is constant regardless of price (e.g., alcohol).
• Non-Habitual Items: Demonstrate elasticity, as demand can change.