ELASTICITY OF DEMAND

Elasticity

Elasticity is the measure of the extent to which a variable reacts in response to the change in

another variable, most commonly this sensitivity is the change in price relative to the

changes in other variables.  In business and economics, elasticity refers to the degree to

which individuals, consumers or producers change their demand or the amount supplied in

response to price or income changes. It is mainly used to identify how consumers’ demand

change in response to change in a good or service’s price.

Concepts of Elasticity of Demand

The up and down movement of price of goods indicates the movement of goods’ quality and

that how customers react to the products/goods they purchase; this explains the law of

demand. However, it does not tell us about the demanded quantity of goods and how much

the demand will change regarding to the price change in goods. That is where the concept of

Elasticity of demand grew.

Contribution of Alfred Marshall

Alfred Marshall gave this law to economics. Elasticity of demand refers to the price

elasticity of demand. Marshall was the first one to define price elasticity of demand, which

predicts how a demand changes after the change on price. In theory, we usually observe that

the demand of a product decreases after the increase in price. However, Marshall noted that

this behavior is not always true and the price of some goods increases without a reduction in
the demand. It has raised lot of debits in many schools of thoughts and has been important

for the formation of economic theories regarding responsiveness of the demand of quantity

of goods by consumers with respect to the change in price.

According to Marshall, ‘The elasticity of demand in a market is great or small as the amount

demanded increases much or little for a given fall in price and diminish much or little for a

given rise in price’. He distinguished five degrees of elasticity, which are elastic, highly

elastic, absolutely elastic, less elastic or inelastic, depending on the elasticity of demand,

which is determined by various factors such as its price, incomes of the people, prices of

correlated goods, substitutes, time element, taste and habit [ CITATION Kir \l 1033 ]. The demand is

elastic if the change in prices affect demand whereas inelastic when demand is invariant after

the change in price. Demand for luxuries are highly elastic, for comfort elastic and for

necessities like food and medication inelastic. Any change in the size of the determinants of

demand will consequently cause change in the quality demanded for a certain good. The

level of responsiveness of amount of requested products suggests an adjustment in its value

or price, salary and costs of related merchandise. Marshall argued that supply and demand,

costs of production, and price elasticity all work in coordination.

Types of Elasticity of Demand

There are three types of elasticity of demand; price elasticity, income elasticity and cross

elasticity.

1. Price Elasticity
It is an economic measure of the change in the quantity demanded of a product in

relation to its price change. Mathematically, it is expressed as:

% change∈quantity demanded
Price Elasticity of Demand=
% change∈ price

In order to understand the working of the real economy, economists use price

elasticity to have an idea how the supply or demand alternates with respect to the price

changes. The more easily a shopper can replace / substitute a product with rising

substitute, the more elastic it will be. As we know that coffee and tea are good

substitutes of each other, either of the two products can easily substitute other when

the increase in the price of one product occurs[ CITATION Exp \l 1033 ]. The following

coefficients describe the value of price elasticity of demand (ped):

i. If Ped = zero, demand is perfectly inelastic i.e. the demand does not change at

all after the change in price. The demand curve will be vertical.

ii. If Ped lies between zero and one, the demand is inelastic that is the percent in

the demanded quantity is smaller than the percent change in price.

iii. If ped = 1, the demand is unit elastic i.e. the change in the demanded quantity is

the same as the change in the price of the good.

iv. If ped > 1, the demand is elastic and the demand of quantity is proportionally

greater than the change in price[ CITATION Wll18 \l 1033 ].

2. Income Elasticity
 Income elasticity of demand refers to the sensitivity of the demanded quantity with

respect to the change in incomes, provided all other variables constant.

Mathematically,

% change∈the quality demanded

With income elasticity of demand, we can differentiate a product as necessity or

luxury.

3. Cross Elasticity

Cross Elasticity of demand is an economic measure of the responsiveness of the

demand of quantity of one good when the price for another good changes. We also call

it cross-price elasticity of demand. It is measured by;

% change∈the demanded quantity of one good

Two products, which are substitutes of each other, will have a positive cross elasticity

while the ones which are supplements of each other, will have a negative cross

elasticity.

Importance of Elasticity of Demand

We saw different concepts of elasticity of demand but most important of them is Price

Elasticity of Demand. It is very helpful in making decisions regarding business, and at

organization, governmental and international level. Following aspects visualize its

importance:

1. International Trade
 It is important to know about the elasticity of demand of goods to fix the price before

exporting them. The international bodies that trade with other companies and countries

fix higher prices for the products having inelastic products. However, if the demand is

elastic in the importing country, then they will have to lower the prices.

2. Formulation of Government Policies

The price of elasticity of demand plays an important role to formulate government

policies especially taxation policy. The goods with inelastic demand tend to have higher

taxes while the goods with the elastic demands will have imposition of lower taxes.

3. Factor Pricing

The companies use price elasticity of demand concept for the determination of prices for

the production factors. Share of each factor in the national product is determined with

respect to its demand in production activity. A factor with an inelastic demand will attract

more rewards than other factors.

4. Decision of Monopolist

Before fixing the price of a product, monopolists consider the nature of the demand in

order to know when to increase or decrease the price of a good. Monopolists also use

price discrimination policy for the same goods in different market, depending on the

demand of the product in the respective markets.

5. Paradox of poverty amidst plenty

Inelastic demand relates to this concept. This happens with the product of high supplies

due to uncalculated production. This cause a decrease in the prices of those products and

at the end revenue falls too[ CITATION Cha1 \l 1033 ].

Particularly speaking, the concept and knowledge of price elasticity of demand applies

to so many circumstances of life and work. This knowledge is a need for all firms in

the production process in order to know exactly when to increase or decrease the price

of the goods in the market to increase the market’s competitiveness.

Works Cited
Chand, S. (n.d.). The Importance of Elasticity of Demand (5 Important Points). Your Article Library.

Retrieved from http://www.yourarticlelibrary.com/economics/the-importance-of-elasticity-

of-demand-5-important-points/8964

Explaining Price Elasticity of Demand. (n.d.). Retrieved from

https://www.tutor2u.net/economics/reference/price-elasticity-of-demand

Kenton,W. (2018, October 22). Price Elasticity of Demand. Retrieved from

https://www.investopedia.com/terms/p/priceelasticity.asp

Shaile, K. (n.d.). Top 14 Contributions of Alfred Marshall to Economics. Economics Discussion.

Retrieved from http://www.economicsdiscussion.net/economics-2/alfred-marshall/top-14-

contributions-of-alfred-marshall-to-economics/21044