Chap 5

Course Title: Fundamentals of Agricultural Economics
Course Code: AES-121

Credit Hours: 2 (2+0)
Department of Agricultural Economics and Statistics
UNIT V: Elasticity of Demand

The term elasticity expresses the degree of correlation between demand and price. It is
the rate at which the quantity demanded varies with a change in price. Elasticity of demand
refers to the sensitiveness or responsiveness of demand to changes in price. Price elasticity of
demand is usually referred to as elasticity of demand.
Types of Elasticity of Demand

The quantity of a commodity demanded per unit of time depends upon various factors
such as the price of a commodity, the money income of the consumer and prices of related
goods, the tastes of the people, etc. Whenever there is a change in any of the variables stated
above, it brings about a change in the quantity of the commodity purchased over a specified
period of time. The three main types of elasticity are now discussed in brief.
(a) Price Elasticity of Demand:

Price elasticity of demand is the degree of responsiveness of quantity demanded of a
good to a change in its price. Precisely, it is defined as the ratio of proportionate change in the
quantity demanded of a good caused by a given proportionate change in price. The formula
for measuring price elasticity of demand is:
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑
𝑃𝑟𝑖𝑐𝑒 𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 =
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
∆𝑞 𝑃
= ×
∆𝑃 𝑞
Where, q = initial quantity ∆𝑞 = 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦

P = Initial Price ∆𝑃 = 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒
Example: Let us suppose that price of a good falls from Rs.10 per unit to Rs.9 per unit in a
day. The decline in price causes the quantity of the good demanded to increase from 125
units to 150 units per day.
The price elasticity using the simplified formula will be:
∆𝑞 𝑃
𝐸𝑃 = ×
∆𝑃 𝑞
Δq = 150 - 125 = 25 ΔP = 10 - 9 = 1
Original quantity = 125 Original price = 10
Ep = 25 / 1 x 10 / 125 = 2.
The elasticity coefficient is greater than one. Therefore the demand for the good is elastic.
(b) Income Elasticity of Demand:
Income is an important variable affecting the demand for a good. When there is a
change in the level of income of a consumer, there is a change in the quantity demanded of a
good, other factors remaining the same. The degree of change or responsiveness of quantity
demanded of a good to a change in the income of a consumer is called income elasticity of
demand. Income elasticity of demand can be defined as the ratio of percentage change in the
quantity of a good purchased, per unit of time to a percentage change in the income of a
consumer.
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑
𝐼𝑛𝑐𝑜𝑚𝑒 𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 =
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐼𝑛𝑐𝑜𝑚𝑒
∆𝑞 𝐼
𝐸𝑦 = ×
∆𝐼 𝑞
Example: Let us assume that the income of a person is Rs.4000 per month and he purchases
six kg of Paneer per month. Let us assume that the monthly income of the consumer increases
to Rs.6000 and the quantity demanded of Paneer per month rises to eight .The elasticity of
demand for CDs will be calculated as under:
Δq = 8 - 6 = 2 Δy = 6000 - 4000 = 2000
Original quantity demanded = 6 Original income 4000
∆𝑞 𝐼
𝐸𝑦 = ×
∆𝐼 𝑞
= 2 / 200 x 4000 / 6
= 0.66
The income elasticity is 0.66 which is less than one.
(c) Cross Elasticity of Demand:

The concept of cross elasticity of demand is used for measuring the responsiveness of
quantity demanded of a good to changes in the price of related goods. Cross elasticity of
demand is defined as the percentage change in the demand of one good as a result of the
percentage change in the price of another good.. The formula for measuring cross elasticity of
demand is:
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 𝑜𝑓 𝐺𝑜𝑜𝑑 𝑋
𝐶𝑟𝑜𝑠𝑠 𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 =
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝐺𝑜𝑜𝑑 𝑌
The numerical value of cross elasticity depends on whether the two goods in question
are substitutes, complements or unrelated.
Two commodities will be complementary, if a fall in the price of Y commodity
increases the demand of X commodity. Likewise if reduction in price of one commodity (say
tea) increases the demand for other commodity (say coffee), they are said to be substitutes.
The cross elasticity of complementary goods is positive and negative of the substitute goods.
For example: Coke and Pepsi are substitutes while bread and butter are complementary
goods.
Degrees of Elasticity
(1) Perfectly inelastic demand: When the quantity demanded of a good does not change at
all to whatever change in price, the demand is said to be perfectly inelastic or the elasticity of
demand is zero.
(2) Perfectly elastic demand: A perfectly elastic demand curve DD’ is a horizontal line
which indicates that the quantity demanded is extremely (infinitely) responsive to price. Even
a slight rise in price drops the quantity demanded of a good to zero. The curve DD’ is
infinitely elastic. This elasticity of demand as such is equal to infinity.
(3) Unitary elastic demand: When the quantity demanded of a good changes by exactly the
same percentage as price, the demand is said to be unitary elastic.
(4) Relatively elastic demand: If a given proportionate change in price causes relatively a
greater proportionate change in quantity demanded of a good, the demand is said to be
relatively elastic. Alternatively, we can say that the elasticity of demand is greater than 1.
(5) Relatively Inelastic demand: When a given proportionate change in price causes a
relatively less proportionate change in quantity demand, demand is said to be inelastic. The
elasticity of a good here is less than 1 or less than unity.
Factors Determining Price Elasticity of Demand:
i. Degree of necessity: If the consumption of the commodity or commodities is
essential and necessary, the demand for those commodities is said to be relatively
inelastic. In developing countries of the world, the per capital income of the people is
generally low. They spend a greater amount of their income on the purchase of
necessaries of life such as wheat, milk, course cloth etc. They have to purchase these
commodities whatever be their price. The demand for goods of necessities is,
therefore, less elastic or inelastic. The demand for luxury goods, on the other hand is
greatly elastic whose consumption can be postponed. For example, refrigerators,
televisions etc.
ii. Availability of substitutes: If a good has greater number of close substitutes
available in the market, the demand for the good will be greatly elastic. For examples,
if the price of Coca Cola rises in the market, people will switch over to the
consumption of Pepsi Cola which is its close cheaper substitute. So the demand for
Coca Cola is elastic.
iii. Proportion of the income spent on the good: If the proportion of income spent on
the purchase of a good is very small, the demand for such a good will be inelastic. For
example, if the price of a box of matches or salt rises by 50%, it will not affect the
consumer’s demand for these goods. The demand for salt, match box therefore will be
inelastic. On the other hand, if the price of a car rises from Rs.6 lakh to Rs.9 lakh and
it takes a greater portion of the income of the consumers, its demand would fall. The
demand for car is, therefore, elastic.
iv. Time: The period of time plays an important role in shaping the demand curve. In the
short run, when the consumption of a good cannot be postponed, its demand will be
less elastic. In the long run if the rise price persists, people will find out methods to
reduce the consumption of goods. For example: if the price of electricity goes up, it is
very difficult to cut back its consumption in the short run than in the long run by
adoption of available alternatives.
v. Number of uses of a good: If a good can be put to a number of uses, its demand is
more elastic (Ep > 1). For example, if the price of coal falls, its quantity demanded
will rise considerably because demand will be coming from households, industries,
railways etc.

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Course Title: Fundamentals of Agricultural Economics

Course Code: AES-121

UNIT V: Elasticity of Demand

Types of Elasticity of Demand

(a) Price Elasticity of Demand:

Where, q = initial quantity ∆𝑞 = 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦

(c) Cross Elasticity of Demand:

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