ELASTICITY OF DEMAND

Elasticity of Demand – It is the responsiveness of demand to the change in various factors

affecting demand. It tells us about by how much the demand for commodity changes due to
the in factors affecting it.

There are three types of Elasticity of Demand

• Price Elasticity Demand.

• Income Elasticity of Demand
• Cross Elasticity of Demand

Price Elasticity of Demand – It is the responsiveness of demand to the change in price of the
commodity. It tells us about by how much demand for a commodity changes due to change
in its price. It is calculated by the following Formula: -
⬚
Ed = % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 ⬚ % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒

Ed = 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑑𝑒𝑚𝑎𝑛𝑑/𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 X100

Derivation of formula
𝜟𝑸 𝜟𝑷
Ed = ( 𝑸 × 𝟏𝟎𝟎) ÷ ( 𝑷 × 𝟏𝟎𝟎)

𝛥𝑄×100 𝑃
× 𝛥𝑃×100
𝑄
𝛥𝑄 𝑃
×
𝑄 𝛥𝑃
𝛥𝑄 𝑃
𝑥
𝛥𝑃 𝑄
When the price of the commodity was ₹10 per unit its quantity demanded was 100 units.
When price came down to ₹8 its quantity demanded went up to 110. Calculate the price
elasticity of demand.
𝛥𝑄 𝑃
Ed = 𝑥
𝛥𝑃 𝑄
110−100 10
= × 100
10−8
10 10
= 𝑋 100
2

=½
= 0.5
Degree of price Elasticity of Demand
1. Perfectly Inelastic Demand (Imaginary goods)

Price Quantity Demanded

1 10
2 10
3 10
4 10

It is a hypothetical case which means it does not exist in real world. It is the case where
demand does not change in price. The value of price elasticity of demand is equal to 0 and the
demand curve is parallel to x axis.

2. Inelastic / less elastic/ relatively inelastic (necessity)

Price Quantity demanded

14 88
10 80

It is a case where with a huge change in price there is a small change in demand. It means
that percentage change is demand is less than percentage change in price. The value of price
elasticity of demand is less than 1. And the demand curve is stipe. All goods falling under
demand curve has an inelastic demand. For e.g., salt, sugar, medicine, etc.
 3. Unitary Elastic (comfort goods)

Price Quantity demanded

10 10
8 12

It is a case where percentage change in demand is equal to percentage change in price. The
value of price elasticity od demand is equal to 1. The demand curve is neither stepper nor
flatter but forming a rectangular hyperbola. All goods falling under comfort category has an
unitary elastic demand.
4. More elastic / Elastic / Relatively Elastic (Luxurious goods)

Price Quantity demanded

80 50
65 110

It is a case where with a small change in price there is a huge change in demand. It means
that percentage change in demand is more than percentage change in price. The value of price
elasticity is more than 1 and demand curve is flatter. All luxurious goods have a elastic
demand.
METHODS OD CALCULATING PRICE ELASTICITY OF DEMAND
1) Percentage method
⬚
Ed = % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑑𝑒𝑚𝑎𝑛𝑑 % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
⬚

% change in demand > % change in price – ed > 1

% change in demand = % change in price – ed = 1
% change in demand < % change in price – ed < 1
 2) Expenditure method / Total out ley method
Price Quantity demanded Expenditure
10 1 10
9 2 18
Case 1 8 3 24
7 4 28
Case 2 6 5 30
5 6 30
4 7 28
Case 3 3 8 24
2 9 18
1 10 10
Case 1 – Price decreases expenditure increases
Price increases expenditure decreases
Therefore price & expenditure have inverse relation ed >1

Case 2 – with the increase or decrease in price expenditure is same ed = 1

Case 3 – Price increases and expenditure increases

Price decreases and expenditure decreases
Therefore Price & expenditure have direct relation ed < 1

Under expenditure method elasticity of demand is calculated by comparing price of a

commodity and expenditure on it. We can understand this with the help of the example given
above. In the above example we can see that when there is a fall in price, expenditure
incurred on the commodity rises and with the rise in price expenditure incurred on the
commodity falls. Elasticity of demand is said to be more than one. It means that when there is
an inverse relation between price and expenditure. Price elasticity of demand is more than
one
In the second case we see that the change in price the expenditure incurred on the commodity
does not change. The elasticity of demand is said to be equal to 1.
In case 3 we see that with fall in price expenditure falls and with rise in price expenditure
rises. The elasticity of demand is less than 1. It means that when there is a direct relation
between price and expenditure. The price elasticity of demand is less than one.
In the above graph the slope AB indicates an inverse relation between price of a commodity
and expenditure made on it. Therefore, it represents price elasticity more than one. The
slope BC indicates that with the change in price expenditure remains same. Therefore price
elasticity of demand equals to 1. The slope CD indicates a direct relation between price of a
commodity and expenditure made on it. Therefore ed < 1.
3) Geometric / Point Method.

EA = AB = BC = CD
𝐸𝑑 = 𝐿𝑜𝑤𝑒𝑟 𝑠𝑒𝑔𝑚𝑒𝑛𝑡 /𝑢𝑝𝑝𝑒𝑟 𝑠𝑒𝑔𝑚𝑒𝑛𝑡
Under Geometrical method, the price elasticity of demand is calculated on a particular point
for demand curve. We can understand this with the help of an example given above. ED is a
linear demand curve measuring 12 cm. B is the mid-point of ED, A is the mid-point of EB and
C is the mid-point of BD. Thus, making EA = AB = BC = CD = 3cm. Under this method the
price elasticity of demand is calculated by the following formulae. Ed = lower segment/upper
segment.
Ed at point B is equal to 6/6 =1

When lower segment is equal to upper segment the value of e d = 1. It means that at mid-
point of linear demand curve ed = 1.
Ed at point C= CD/EC, 3/9 = 0.33
When lower segment is less than upper segment the value of e d < 1. It means that when ed is
calculated at a point which is below the mid-point of a demand curve ed will be less than 1.
Ed at point A = AD/EA. 9/3 = 3
When lower segment will be more than the upper segment the value of e d > 1. It means that
when ed is calculated at point which is above the mid-point of a demand curve ed > 1.
4) Income elasticity of Demand
Income elasticity of demand is the responsiveness of demand to the change in income of
the consumer. It tells us about how the demand for a commodity changes due to change in
income of the consumer. It is calculated by using the following formulae: -
⬚
𝐸𝑑 = % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑐𝑜𝑚𝑒
⬚
There are three types of income elasticity of demand: -
I. Positive Income Elasticity of D3mand
a) When with an increase in the income of the consumer demand for the
commodity also increases and vice-versa.
b) The income elasticity of demand for such products is said to be positive.
c) This happens in the case of normal goods as there exists a direct relation
between income of the consumer and demand of normal goods.

II. Negative Income Elasticity of Demand

a) When with an increase in the income of the consumer, demand for the
commodity falls and vice-versa.
b) The income elasticity of demand for such products is said to be negative.
c) This happens in the case of inferior goods as there exist an inverse relation
between Income of the of the consumer and the demand for inferior goods.

III. Zero income elasticity of demand

In case of neutral necessity like salt, sugar, match-boxes etc. the income elasticity
of demand will be zero. It is so because demand for such commodity does not
change with change in Income of the consumer.

IV. Cross elasticity of Demand

Cross elasticity od demand takes place in case of related goods. It is the
responsiveness of demand for goods Y due to the change in price of goods X. It is
calculated using the formulae: -
⬚
𝐸𝑑 = % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑑𝑒𝑚𝑎𝑛𝑑 𝑓𝑜𝑡 𝑌 % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑑𝑒𝑚𝑎𝑛𝑑 𝑓𝑜𝑟 𝑋
⬚
Case I
In case of substitute goods, the value of cross elasticity of demand will be
positive. It is so because there exists a direct relation between price of a
commodity and demand for its substitute. For example, tea and coffee.
Case II
In case of complementary goods, the value of cross elasticity of demand will be
negative. It is so because there exists an inverse relation between price of a
commodity and demand for its complementary goods. For example, car and
petrol.
Case III
In case of unrelated products, the value of cross elasticity of demand will be 0. For
example, shoes and nail polish.
Factors affecting price elasticity of demand
a. Availability of Substitutes – The elasticity of demand for the product depends a lot
upon the availability of substitutes. A product whose substitute are available in the
market has an elastic demand. As a consumer has an option to switch to the substitute
products in the event of rise in the price. For example, if the price of thumps up rises
people start purchasing Pepsi.
On the other hand of the product whose substitutes are not available in the
market has an inelastic demand, even if the price of the product rises people has no
option but to purchase the product at the higher price.

b. Proportion of income spent – The product on which a consumer spent a very small
proportion of their income has an inelastic demand as any change in price of the
product does not affect the budget of the consumer. For example, needle, matchbox,
newspaper etc.
Contrary to this a product on which a consumer spent a very huge proportion of
their income has an elastic demand as any change in price of these products affect the
budget of the consumer to a great extent. Example mobile phones, car etc.
c. Time period – In most of the cases demand for a product in short run remains
inelastic whereas demand for the same product in long run remains elastic. This is
because in the short run it becomes difficult to find out the substitutes for the product
or to give up the consumption of product if we are addicted to it. However, in the long
run both are possible due to which demand falls with the rise in price.

d. Possibility of postponement – A product whose use can be postponed to the future

date has an elastic demand as the consumer can wait for the price of such product to
fall before, they can actually purchase it.
Contrary to this a product whose use cannot be postponed to the future date
has an inelastic demand. For example, medicine, salt, etc.
e. Habitual Necessities – Commodities which has become habitual necessity for the
consumer has less elastic demand. It is so because such commodity become a
necessity for the consumer to survive because of which the consumer continues to
consume at a higher price.
 Q) What is the relationship between Price elasticity of Demand and Total Revenue?
Ans) In case of product having an inelastic demand
Case I Case II
P = 100 NP = 150 NP = 50 P˄ TR ˄
Q = 100 NQ = 90 NQ = 110 P˅ TR˅
TR = 1000 NR = 13500 NR = 5500

Demand does not vary much. (Direct relation)

In the case of products having inelastic demand, there exists a direct relation between
price of a commodity and a total revenue generated. It means that with an increase in price
the total revenue generate also increases and vice-versa. We can understand this with the help
of an example given above.
Due to huge change in price, total revenue falls in In elastic demand.
In the above example, In
Case I. we can see that when price of the commodity increases from ₹100 to ₹150 even after
the fall in demand. The total Revenue rises from ₹10000 to ₹13500.
Case II. When price falls from ₹100 to ₹50 even after the rise in quantity demanded, Total
Revenue falls from ₹10000 t0 ₹5500. Therefore, we can conclude that in the case of product
having inelastic demand. It is always beneficial to increase the price.
In case of product having elastic demand.
Case I Case II
P = 100 NP = 110 NP = 90 P˄ TR˅
Q = 100 NQ = 50 NQ = 150 P˅ TR˄
TR = 1000 NR = 5500 NR = 13500

Demand varies greatly (inverse relation)

In the case of product having elastic demand, there exists an inverse relation between price of
a commodity and total revenue generated. It means that with an increase in price, Total
Revenue generated will fall and vice-versa. We can understand this with the help of the given
example: -
Case I . We can see that when price rises from ₹100 to ₹110, the total revenue generated also
falls from ₹10000 to ₹5500.
Case II We can see that even after the fall in price from ₹100 to ₹90, the total revenue
generated increases from ₹10000 to ₹13500. Therefore, we can conclude that products having
elastic demand is always beneficial to decrease the price.
Therefore, due to change in price, Total revenue falls in elastic demand.