What is Elasticity of Demand?
Demand that is relatively elastic suggests that a change in the price of a good or service will have an effect on the quantity required of that good or service. A product or service is typically said to have significant price elasticity when there are several replacements available.
Example: You might see salt and a variety of salt alternatives when you browse the aisle at the grocery store. Would you be willing to pay an extra 2 for a bag of salt if there were salt replacements instead if the price of salt increased by 2 per bag tomorrow? Most people would switch from preferring salt to one that contains sugar substitutes, which would lower their demand for pure salt. Since most economists concur, salt is viewed as a good with a high degree of elasticity.
Relatively Elastic demand
Relatively Elastic demand
Types of Elasticity of Demand
Elasticity of demand is classified into three types based on the many elements that influence the quantity desired for a product:
Price Elasticity of Demand (PED),
Income Elasticity of Demand (IED) (YED), and
Cross Elasticity of Demand (XED)
1)Price Elasticity of Demand (PED)
The Price Elasticity of Demand (PED) is the quantity requested for a product is affected by any change in the price of a commodity, whether it be a drop or an increase. For example, as the price of ceiling fans rises, the quantity requested decreases.
The Price Elasticity of Demand is a measure of the responsiveness of quantity sought when prices vary (PED).
The mathematical formula for calculating Price Elasticity of Demand is as follows:
PED = %Change in Quantity Demanded % / Change in Price.
The formula's output determines the magnitude of the influence of a price adjustment on the amount required for a commodity.
2). Income Elasticity of Demand (YED)
The Income Elasticity of Demand (YED) is the Consumer income levels have a significant impact on the amount requested for a product. This may be seen in the contrast between commodities sold in rural marketplaces and those sold in urban markets.
The Income Elasticity of Demand, commonly known as YED, refers to the sensitivity of the quantity requested for a certain commodity to changes in real income (the income generated by a person after accounting for inflation) of the consumers who buy this good, while all other variables remain constant.
The formula for calculating the Income Elasticity of Demand is as follows:
YED = % Change in Quantity Demanded% / Change in Income
The formula's output may be used to assess if a product is a need or a luxury item.
3. Cross Elasticity of Demand (XED)
In the Cross Elasticity of Demand (XED), in an oligopolistic market, numerous companies compete. Thus, the amount desired for a commodity is affected not only by its own price, but also by the prices of other items.
Cross Elasticity of Demand (XED) is an economic term that assesses the sensitivity of quantity requested of one good (X) when the price of another item (Y) changes, and is also known as Cross-Price Elasticity of Demand.
The formula for calculating the Cross Elasticity of Demand is as follows:
XED = (% Change in Quantity Demanded for one good (X)%) / (Change in Price of another Good (Y))
The result for a substitute good would always be positive since anytime the price of an item rises, so does the demand for its alternative. In the case of a complementary good, however, the outcome will be negative.
What Makes a Product Elastic?
A product is considered elastic when even a small change in its price causes a significant change in how much people buy. This often happens when there are plenty of substitutes available, meaning buyers can easily switch to a similar product if the price rises. Products that are not essential or are considered luxury items tend to be more elastic because people can reduce or delay their purchases when prices increase. Additionally, if a product takes up a large portion of a person’s budget, they are more likely to react to price changes, making it more elastic.
Factors Affecting Elasticity of Demand
The more substitutes available, the easier it is for people to switch, making demand more elastic.
Necessities are inelastic because people need them, while luxuries are elastic as they can be skipped.
Expensive items that take up a large part of income are more elastic, while cheaper items are inelastic.
Demand is more elastic in the long run because people have time to find alternatives or adjust.
Products that are addictive, like cigarettes or coffee, have inelastic demand as people keep buying them despite price changes.
Importance of Elasticity of Demand
Businesses use elasticity to decide pricing strategies. If demand is inelastic, they can raise prices to boost revenue without losing many customers.
Governments focus on taxing inelastic goods (like fuel or tobacco) because people continue buying them even with higher taxes.
Elasticity helps businesses understand if lowering prices will attract more buyers and increase overall revenue.
Policymakers use elasticity to predict how price changes (e.g., in essential goods) will affect consumer spending and the economy.
Countries prioritize exporting goods with inelastic demand to ensure stable trade revenues even during price fluctuations.
Relatively Elastic Demand Example
The majority of necessities tend to be very inelastic.
Example : A youtube business with 50,000 subscribers offers a service for 100 a year. The corporation increases the subscription service's cost by 30%, from 100 per year to $130. The company now has 52,000 users, a 4 % increase after the price rise. The service is comparatively inelastic because the price increased by 30% while the demand increased by only 4%.
Conclusion
Economists attempt to quantify the degree to which demand is sensitive to changes in price for a particular good using the concept of price elasticity of demand. This assessment can be helpful in predicting consumer behaviour as well as big occurrences like an economic recession or recovery. Every day, as customers, we make choices that economists track. We may consume less of a good or none at all if its price rises and we can survive without it, there are many replacements, or both. Despite price hikes, we will continue to demand large amounts of water, medicine, and gasoline as needed.
FAQs on Elasticity of Demand: Types and Applications
1. What is meant by elasticity of demand in economics?
Elasticity of demand is an economic concept that measures how responsive the quantity demanded of a good or service is to a change in one of its determinants, such as its price, consumer income, or the price of related goods. In simple terms, it shows how much the demand for a product changes when its price or other factors change. It helps in understanding consumer behaviour and is crucial for business and government policy decisions.
2. What are the three primary types of elasticity of demand?
The three main types of elasticity of demand are:
- Price Elasticity of Demand (PED): This measures the responsiveness of the quantity demanded of a good to a change in its own price. It is the most common type of elasticity.
- Income Elasticity of Demand (YED): This measures how the quantity demanded of a good changes in response to a change in consumers' real income.
- Cross Elasticity of Demand (XED): This measures how the quantity demanded of one good changes in response to a change in the price of another related good (either a substitute or a complement).
3. How do businesses use the concept of price elasticity of demand for making pricing decisions?
Businesses use price elasticity of demand as a key tool to set their pricing strategy and maximise revenue.
- If a product has inelastic demand (demand doesn't change much with price), a business can increase its price to earn higher revenue, as the drop in sales will be minimal. This is common for essential goods.
- If a product has elastic demand (demand is highly sensitive to price), a business might consider lowering its price. The increase in the number of units sold could be significant enough to offset the lower price, leading to higher overall revenue. This is often true for luxury items or goods with many substitutes.
4. What are the key factors that determine the price elasticity of demand for a product?
Several factors influence whether the demand for a product is elastic or inelastic. The most important ones are:
- Availability of Substitutes: The more substitutes a product has, the more elastic its demand.
- Nature of the Commodity: Necessities (like salt, basic food) tend to have inelastic demand, while luxuries (like designer clothes, sports cars) have elastic demand.
- Proportion of Income Spent: Goods that take up a small portion of a consumer's income (e.g., a matchbox) have inelastic demand. Expensive items have more elastic demand.
- Time Period: Demand is generally more elastic in the long run as consumers have more time to find alternatives or adjust their habits.
5. What is the practical difference between a perfectly elastic and a perfectly inelastic demand curve?
The difference lies in the consumer's response to price changes. Perfectly inelastic demand (elasticity = 0) means consumers will buy the same quantity regardless of the price. This is theoretical but can be approached by life-saving drugs. The demand curve is a vertical line. In contrast, perfectly elastic demand (elasticity = infinity) means consumers will buy an infinite amount at a specific price, but none at all if the price increases even slightly. This occurs in perfectly competitive markets where all goods are identical. The demand curve is a horizontal line.
6. How does cross elasticity of demand help identify whether goods are substitutes or complements?
The value of cross elasticity of demand (XED) reveals the relationship between two goods:
- If the XED is positive, the goods are substitutes. This is because an increase in the price of one good (e.g., coffee) leads to an increase in the demand for the other good (e.g., tea).
- If the XED is negative, the goods are complements. This is because an increase in the price of one good (e.g., cars) leads to a decrease in the demand for the other good (e.g., petrol).
- If the XED is zero, the goods are unrelated.
7. How can the value of income elasticity of demand indicate if a good is a necessity, a luxury, or an inferior good?
The value and sign of income elasticity of demand (YED) classify goods based on how demand changes with income:
- Normal Goods (Positive YED): Demand increases as income increases.
- If YED is greater than 1, it's a luxury good (demand increases more than proportionally to income).
- If YED is between 0 and 1, it's a necessity good (demand increases less than proportionally to income).
- Inferior Goods (Negative YED): Demand decreases as income increases, as consumers switch to better alternatives. For example, demand for coarse grains may fall as income rises.
8. How is price elasticity of demand calculated using the percentage method as per the CBSE syllabus?
As per the CBSE 2025-26 syllabus, the percentage method is a standard way to calculate price elasticity of demand (Ed). The formula is:
Ed = (Percentage Change in Quantity Demanded) / (Percentage Change in Price)
Here, the percentage change in quantity demanded is calculated as [(New Quantity - Old Quantity) / Old Quantity] × 100, and the percentage change in price is calculated as [(New Price - Old Price) / Old Price] × 100.
9. Does a straight-line demand curve have the same elasticity at all points? Explain why or why not.
No, a straight-line (linear) demand curve does not have the same elasticity at all its points, even though its slope is constant. Elasticity is the ratio of percentage changes, not absolute changes. On a linear demand curve:
- At the top-left portion (high price, low quantity), demand is elastic (Ed > 1).
- At the midpoint, demand is unit elastic (Ed = 1).
- At the bottom-right portion (low price, high quantity), demand is inelastic (Ed < 1).
This is because the percentage change in quantity and price varies along the curve.
