ELASTICITY OF

DEMAND
The law of demand shows that there is an inverse relationship
between the quantity demanded and price. The law merely
shows the direction of change ie.
P Qd and P Qd

It does not show the extent of change in quantity

demanded when price changes. i.e., it does not specify the
magnitude or the amount or extent by which demand changes
with a change in the price. Hence, law of demand does not have
any utility in business decisions.
Prof. Alfred Marshall offered more useful concept i.e., price
elasticity of demand which measures the extent of change
in quantity demanded when price changes.
Elasticity of demand :

It measures the extend of relationship between quantity

demanded of a commodity as a result of a change in any factor
which affects demand like price, income, price of other related
goods advertisement expenditure etc. Thus we have the
following concepts of elasticity of demand.
• price elasticity
• Income elasticity
• Cross elasticity
• Advertisement elasticity
 Price elasticity

It measures the responsiveness or sensitiveness in

quantity demanded of a commodity as a result of a
change in the price of that commodity.
i.e. elasticity of demand is a technical term used by economists
to decide the degree of responsiveness of the demand for a good
to a change in its price (Stonier and Hague)
Price elasticity of demand is denoted by the letters ep. ep is a
non negative value.
Price elasticity of demand can be estimated by two basic
methods
1. percentage method 2. proportionate method
 Percentage method
Price elasticity can be measured by dividing the percentage
change in quantity demanded to percentage change in
price

Ep = percentage change in quantity demand/

percentage change in price
When the price of a commodity increases by 20 percent, if the
quantity demanded of that commodity decreases by 28 percent find
price elasticity of demand.
When the price of a commodity falls by 18 percent the quantity
demands increases by 25 percent, find ep.
When price increases by party 22 percent the elasticity of demand is
estimated as 2.4. what would be the change in quantity demanded.
 Proportionate method:

Price elasticity of demand can also be estimated by

dividing proportionate change in quantity demanded by
proportionate change in price, i.e.
Ep =proportionate change in quantity demand
proportionate change in price

change in quantity demand

initial quantity demanded
ep = _change in price
initial price
• Using the symbols:
ep = ∆Qd / Qd
∆P/P
ep = ∆Qd / Qd (or) ep = ∆Qd X P
∆P/P ∆P Qd
ep = Change in quantity demanded X Price
Change in price Quantity demanded
 Problems:
When the price of a commodity increase from Rs 8 to 10, the
quantity demanded of declines from 550 units to 355 units. Find
ep

Solution:
When the price of a commodity decrease from Rs 10 to 8, the
quantity demanded of declines from 355 units to 550 units. Find
ep
 Types of Price Elasticity Demand
• On the basis of value price elasticity
con be classified into five different
types. They are:
1. Perfectly elastic demand
2. Perfectly inelastic demand
3. Elastic demand
4. Inelastic demand
5. Unitary elastic demand
 Perfectly elastic demand

• When a small change in price of a product causes a

major change in its demand, it is said to be perfectly elastic
demand. In perfectly elastic demand, a small rise in price
results in fall in demand to zero, while a small fall in price
causes increase in demand to infinity. In such a case, the
demand is perfectly elastic.
ep = ∞
• The demand for the output of a perfectly
competitive firm is perfectly elastic

The demand curve is parallel to x axis at the height of the

price
Diagram representing perfectly elastic demand
 Perfectly Inelastic demand
• A perfectly inelastic demand is one when there is
no change in the demand of a product with
whatever change in its price. The numerical value
for perfectly inelastic demand is zero (ep=0).
• In case of perfectly inelastic demand, demand
curve is represented as a straight vertical line,
which is shown in the following diagram.
Eg salt, newspaper, match box drugs etc.,
Diagram representing perfectly inelastic demand
 Elastic demand :

When the proportionate change in price causes more than

proportionate change in demand, demand is said to be or elastic
demand( relatively elastic demand). For example, if the price of a
product increases by 20% and the demand of the product decreases by
25%, then the demand would be elastic.
i.e. ∆Q/Q > ∆P/P
The numerical value of relatively elastic demand ranges between
one to infinity but not infinity
Mathematically, elastic demand is known as more than unit
elastic demand (ep > 1).

Eg: luxuries and comforts

Diagram representing elastic demand
 Inelastic demandd

When the proportionate change in price causes less than

proportionate change in demand, demand is said to be inelastic
demand. For example, if the price of a product increases by 20%
and the demand of the product decreases by 15%, then the
demand would be inelastic
i.e. ∆Q/Q < ∆P/P
The numerical value of inelastic demand ranges between
zero to one
Mathematically, elastic demand is less than unit elastic
demand (ep < 1).
Eg. Necessaries: food grains, cooking oil, fuel, vegetables etc
Diagram representing inelastic demand
 Unitary Elastic Demand
When the proportionate change in price is
equal to proportionate change in demand,
demand is said to be Unitary elastic demand. For
example, if the price of a product increases by
20% and the demand of the product decreases by
20%, then the demand would be unitary inelastic
i.e. ∆Q/Q = ∆P/P
• The numerical value of unitary elastic demand
is equal to one. It is also called as unit elastic
demand
Diagram representing unitary elastic demand
• Price elasticity and slope of demand curve are
different.
Price elasticity (ep) = ∆Qd X P
∆P Qd
slope of demand curve = 1
∆Qd / ∆P
 Other methods of measuring price elasticity :

1. Total outlay method

2. Point method
3. Arc method
 Total outlay method :

• It is also called total expenditure or

total revenue method. The elasticity
of demand for a commodity is
observed by comparing the total
expenditure on a commodity before
and after change in price.
 By using this method, it can be found whether the price
elasticity is unitary elastic or inelastic or elastic. The total
expenditure or total revenue can be observed by P X Q.

When the total expenditure remains the same for what ever
change in price, ep is said to be unitary elastic. Ie ep = 1
P No.of units TE TR
50 10 500 500
60 8.3 500 500 Ep= 1
40 12.5 500 500
When the price of a commodity increases, if total expenditure
also increases (total revenue increases)
(Or)
When price falls, if total expenditure on that commodity falls
(total revenue falls),
the commodity is said to have inelastic demand i.e. ep < 1
P No.of units TE TR
50 10 500 500
60 9 540 540 Ep< 1
40 11 440 440
When TE varies indirectly with price i.e.
When price increases, if TE decreases (TR falls) and when price
falls TE increases (TR increases)
it said to be elastic demand i.e. ep > 1

P No.of units TE TR
50 10 500 500
60 7 420 420 Ep> 1
40 14 560 560
 It can be summarised as follows :

Increase decrease No change

TE/TR
Price
Increase Ep < 1 Ep > 1 Ep =1
inelastic elastic Unitary elastic
Decrease Ep > 1 Ep < 1 Ep =1
elastic inelastic Unitary elastic
 Point method :

• It means estimating price elasticity at a

particular price, i.e. estimating price
elasticity at a particular point on a given
demand curve (geometrical method)
and estimating price elasticity at a given
price for the given demand function
(differentiation method). Thus there
are two methods of estimating price
elasticity
Geometrical method:
Elasticity of demand at a particular
point on a straight line demand curve touching
the axis is called point elasticity. It is measured
by dividing
ep= Lower Segment / upper segment
Lower Segment is the lower part of the
demand curve from the point at which the price
elasticity is to be estimated
The remaining part of the demand
curve is called as upper segment
 Differential method

It is based that the change in price is very small ie almost equal

to zero but not zero. In that case the formula is

ep = dQ . P
dp q

It is derived from the basic formula:

ep = ∆Qd X P
∆P Qd
Where dq/dp is the derivative of the given dd function
Given the demand function Q= 1000-10p2, find price elastiity
when p=6

Solution

P=6
Q= 1000-10 (6) 2
= 1000-360 = 640
Dq/dp = d/dp (1000-10(p)2) = 20p
Ep = -20 (p) D/Q
= 20(6) 6/640
= 120x6/640 = 9/8 = - 1.25
 Arc elasticity:

When the price change is somewhat larger or when price

elasticity is to he found between two prices, the questions arises
which price, the question arises which price and quantity should
be taken this is because elasticity's found by using original price
and quantity as base will be different from the one derived by
using new price and quantity.
To avoid this confusion midpoint method is used i.e. The
averages of the two prices and quantities.
(arc is a line joining two points on a curve)
∆Q P1 + P2
Ep = _____ X _______
∆P Q1 + Q2
 When the price of a commodity increases from Rs.8 to
Rs.10 the quantity demanded decreases from 550 units to 355
units. Find price elasticity by using point method or Arc methods
 Factors affecting price elasticity
1. Nature of the commodity
The elasticity for a commodity is determined by its
nature whether it is necessary or comfort or luxury
Necessities – inelastic dd
Luxuries & comfort – elastic dd

2. Availability of close substitutes

If close substitutes are available the demand for the
commodity will be elastic. Eg tea and coffee. If price coffee
increases, tea becomes relatively cheaper. The demand for Tea
will increase. Therefore the demand for coffee declines
considerably and becomes elastic.
If there is no close substitutes, the demand for the
commodity will be inelastic
 3. Extend of uses of the commodity :

If the commodity under consideration has several uses, then its

demand is elastic.
Electricity steel, coal, water milk etc.
When price is high – it will be put only to more urgent use
(elastic)
When price falls – it will be used for all different uses.
The commodities that have no alternation uses, the demand is
less elastic.
In case of single use good, the consumer has to consume same
amount since it is used for the same purpose.
 Income

When the disposable income is high, the consumers do not

bother about increase in price, they will buy same quantity.
Thus the demand becomes inelastic only in case of high income
group.
In case of low and middle income groups, the increase
in price is a matter of concern for them and their demand will
change when price changes. Therefore demand becomes elastic
 Price level

In case low priced items demand is inelastic. Salt,

newspaper, match box.
In case of high priced items the demand is elastic.
( consumer durables)
However the demand is inelastic in case of very high
priced items like gold, diamonds etc.
Proportion of total income spent on a commodity (place of
a good in consumer budget)

If the consumer spends very small proportion of his total

disposable income on the purchases of a commodity, the
demand is inelastic. This is because the consumer is not
concerned for price changes in these commodities
as it does not affect his consumption pattern. Eg, salt matches,
pens, pencils, etc.
If the proportion of disposable income spent on a
purchase of a commodity is large ( house rent consumer
durables), elasticity of demand for a such a commodity is
elastic.
 Habitual goods:

The demand for those goods which are habitually

consumed is always inelastic. The reason is that such
commodities become a necessity for the consumers and even if
price increases, consumers continue to purchase and consume
the commodity. Alcoholic beverages, tobacco narcotic drugs
etc.,.
Time factor:
Elasticity of demand varies with the length of time period
the consumer takes to adjust the price changes.

Shorter the time period the demand is inelastic, because

no adjustment is possible.

Longer the time period for adjustment in consumption is

possible therefore the demand becomes elastic. There are three
possible reasons for long period elasticity to be higher than the
short period.
a. Consumers have better knowledge of prices in the long run
b. They can readjust their budgets
c. It is possible for a change in consumption pattern due to
availability of substitutes.
 Tied demand

It means the demand for a good is tied to the demand

of others. Or when the demand for a good is connected to
some other goods.Eg. Printers and cartridges. Incase of these
goods, the demand is inelastic.
 Uses of the concept of price elasticity
1. Price elasticity helps the manager to know the effect
of a price change on their total sales and revenues.
2. Price elasticity helps in arriving at an optimal pricing
strategy for a monopolist. It also useful for price
discrimination.
3. Knowledge of price elasticity is important for
government to determine the prices of goods
supplied by them
4. It helps the government to understand the
responsiveness in demand to the increases in prices
on a result of additional taxes.