Business men know that they face demand curves, but rarely do they know what these curves look like. Yet sometimes a business needs to have a good idea of what part of a demand curve looks like if it is to make good decisions. If Rick's Pizza raises its prices by ten percent, what will happen to its revenues? The answer depends on how consumers will respond. Will they cut back purchases a little or a lot? This question of how responsive consumers are to price changes involves the economic concept of elasticity. Show
As developed by Alfred Marshall, the concept of elasticity was applied to elasticity of price. But later on, the concept was made more broader. Elasticity of demand is a concept of showing the responsiveness of demand. As we well-known earlier, changes in demand can be caused by several factors which determine demand for a good or commodity. Obviously, demand is responsive to each of these factors i.e. But all the factors are not equally important from the point of view of either theoretical analysis or practical means. For example, take tastes or preference of the consumers, is an exogenous factor and there is no point in measuring the responsiveness of demand to this factor, though in practice this factor is important. Efforts, therefore are made to measure the responsiveness of demand to changes in certain important factors like price, income, prices of related products, sales promotion etc. Let us take price as a factor for understanding the elasticity concept. When considering the responsiveness of the quantity demanded to change in price of a commodity, we may make some statements such as : 'The demand for sugar was more responsive to price-changes twenty years ago than it is today', or the demand for milk responds more to price changes than does the demand for tea'. It is thus clear that the degree of responsiveness of quantity demanded to price changes varies from product to product. Elasticity of demand indicates the degree of responsiveness of quantity demanded to changes in market price. Hence this becomes the concept of price-elasticity of demand. DEGREES OF PRICE ELASTICITY Different commodities have different price elasticities. Some commodities have more elastic demand while others have relative elastic demand. Basically, the price elasticity of demand ranges from zero to infinity. It can be equal to zero, less than one, greater than one and equal to unity. According to Dr. Marshall : "The elasticity or responsiveness of demand in a market is great or small according as the amount demanded increases much or little for a given fall in price and diminishes much or little for a given rise in price."However, some particular values of elasticity of demand have been explained as under ; Types of Price Elasticity of Demand:-
MEASUREMENT OF PRICE ELASTICITY OF DEMAND There are five methods to measure the price elasticity of demand.
Total Expenditure Method Dr. Marshall has evolved the total expenditure method to measure the price elasticity of demand. According to this method, elasticity of demand can be measured by considering the change in price and the subsequent change in the total quantity of goods purchased and the total amount of money spend on it. Proportionate Method This method is also associated with the name of Dr. Marshall. According to this method, "price elasticity of demand is the ratio of percentage change in the amount demanded to the percentage change in price of the commodity." It is also known as the Percentage Method, Flux Method, Ratio Method, and Arithmetic Method. A general measure of the responsiveness of an economic variable in response to a change in another economic variable What is Elasticity?Elasticity is a general measure of the responsiveness of an economic variable in response to a change in another economic variable. Economists utilize elasticity to gauge how variables affect each other. The three major forms of elasticity are price elasticity of demand, cross-price elasticity of demand, and income elasticity of demand.  Summary
Price Elasticity of DemandPrice elasticity of demand demonstrates how a change in price affects the quantity demanded. It is computed as the percentage change in quantity demanded over the percentage change in price, and it will commonly result in a negative elasticity because of the law of demand. The law of demand states that an increase in price reduces the quantity demanded, and it is why demand curves are downwards sloping unless the good is a Giffen good. It is common to simply drop the negative of the quotient. The larger the price elasticity of demand, the more responsive quantity demanded is given a change in price. When the price elasticity of demand is greater than one, the good is considered to demonstrate elastic demand. When the quantity demanded drops to zero with a rise in price, it is said that demand is perfectly elastic. If the price of an elastic good increases, there is a corresponding quantity effect, where fewer units are sold, and therefore reducing revenue. The lower the price elasticity of demand, the less responsive the quantity demanded is given a change in price. When the price elasticity of demand is less than one, the good is considered to show inelastic demand. When the quantity demanded does not respond to a change in price, it is said that demand is perfectly inelastic. If an inelastic good has its price increased, it will lead to increased revenues because each unit will be sold at a higher price. If a change in price comes with the same proportional change in the quantity demanded, it is said that the good is unit elastic. Indicating that X% change in price results in an X% change in the quantity demanded. Therefore, if the price elasticity of demand equals one, the good is unit elastic. If a good shows a unit elastic demand, the quantity effect and price effect exactly offset each other. Calculation of Price Elasticity of Demand through the Midpoint MethodThe midpoint method is a commonly used technique to calculate the percent change of price. The primary difference is that it calculates the percentage change of quantity demanded and the price change relative to their average. Examples of Goods with a Price Inelastic Demand
Examples of Goods with a Price Elastic Demand
Factors That Affect the Price Elasticity of Demand1. Availability of close substitutesIf consumers can substitute the good for other readily available goods that consumers regard as similar, then the price elasticity of demand would be considered to be elastic. If consumers are unable to substitute a good, the good would experience inelastic demand. 2. If the good is a necessity or a luxuryThe price elasticity of demand is lower if the good is something the consumer needs, such as Insulin. The price elasticity of demand tends to be higher if it is a luxury good. 3. The proportion of income spent on the goodThe price elasticity of demand tends to be low when spending on a good is a small proportion of their available income. Therefore, a change in the price of a good exerts a very little impact on the consumer’s propensity to consume the good. Whereas, when a good represents a large chunk of the consumer’s income, the consumer is said to possess a more elastic demand. 4. Time elapsed since a change in priceIn the long term, consumers are more elastic over longer periods, as over the long term after a price increase of a good, they will find acceptable and less costly substitutes. Other Demand Elasticities1. Cross-Price Elasticity of DemandThe cross-price elasticity of demand measures how the demand for one good is impacted by a change in the price of another good. It is calculated as the percentage change of Quantity A divided by the percentage change in the price of the other. If the cross-price elasticity of demand between two goods is positive, it implies that the two goods are substitutes. Consider the following substitute goods – good A and good B. If the price of good B rises, the demand for good A rises. On the contrary, if the aforementioned goods were complements, when the price of good B increases, the demand for good A should decrease. It is what is implied through the cross-price elasticity of demand formula. It is important to note that the cross-price elasticity of demand is a unitless measure. 2. Income Elasticity of DemandThe income elasticity of demand is defined as the measure of the percentage change of the quantity demanded of a good in reference to changes in the consumer’s income. Calculating the income elasticity of demand allows economists to identify normal and inferior goods, as well as how responsive quantity demanded is to changes in income. If the income elasticity of demand is positive, the good is considered to be a normal good – implying that when income increases, the quantity demanded at any given price increases. If the income elasticity of demand is negative, the good is considered to be an inferior good – implying that when income increases, the quantity demanded at any given price decreases. If the income elasticity of demand is higher than 1, then the good is considered to be income elastic – implying that demand rises faster than income. Luxury goods include international vacations or second homes. If the income elasticity of demand is higher than 0 but less than 1, then the good is income inelastic – implying that demand for income-inelastic goods rises but at a slower rate than income. Additional Resources Thank you for reading CFI’s guide on Elasticity. To keep learning and advancing your career, the following resources will be helpful:
What is the measure of responsiveness of demand to the changes in price called?The measure economists use to describe the responsiveness of demand for a good or service to a change in the price of another good or service is called the cross price elasticity of demand, e A, B.
What elasticity of demand is a measure of how responsive demand is to a change in consumer income?Income Elasticity of Demand
Represented by the ratio between percentage change in quantity demanded and percentage change in income: If the percent change in the quantity demanded is greater than the percent change in consumer income, the demand is said to be income elastic, or responsive to changes in consumer income.
Is a measure of the responsiveness of the quantity demanded of a good to a change in income when all other influences on buyers plans remain the same?The price elasticity of demand is units-free measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buying plans remain the same.
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Of demand is a measure of how responsive the quantity demanded is to a change in price.
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