In this Article we are Going to Discuss about Elasticity of Demand Meaning, Types, Degrees and Factors influencing Price Elasticity of Demand. Micro Economics Notes B.Com 1st Sem || Micro Economics Notes B.Com 5th Sem
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Elasticity of Demand Meaning and Definition
The term elasticity was developed by Alfred Marshall, and is used to measure the relationship between price and quantity demanded. The law states that the price of a commodity falls, the quantity demanded of that commodity will increase, i.e. it explains only the direction of change in demand and not the extent of change. This deficiency is removed by the concept of elasticity of demand.
Elasticity means responsiveness. Elasticity of demand refers to the responsiveness of quantity demanded of a commodity to change in its price.
According to E.K. Estham, “Elasticity of demand is a measure of the responsiveness of quantity demanded to a change in price”.
According to Muyers “Elasticity of demand is a measure of the relative change in the amount purchased in response to any change in price or a given demand curve”.
According to A.K. Cairncross “The elasticity of demand for a commodity it is the rate at which quantity bought changes as the price changes.”
Types of Elasticity of Demand
These are three types of elasticity
1. Price elasticity
2. Income elasticity – It is of three types.
a) Zero income elasticity
b) Negative income elasticity
c) Positive income elasticity
3. Cross elasticity – It is of two types.
a) Advertisement elasticity and
b) Elasticity of price expectation.
1. Price Elasticity (EP):
Price elasticity of demand may be defined as the degree of responsiveness of quantity demanded of a commodity in response to change in its price i.e. it measures how much a change in price of a good affects demand for that good, all other factors remaining constant. It is calculated by dividing the proportionate change in quantity demanded by the proportionate change in price.
EP= Proportionate change in quantity demanded/ Proportionate change in price
2. Income elasticity (EY):
Income elasticity of demand measures how much a change in income affects demand for that commodity if the price and other factors remain constant.
EY= Proportionate change in quantity demanded/ Proportionate change in income
A product with an income elasticity of more than one will experience a growth in demand that is higher than growth in consumer’s income. Luxury goods tend to have relatively high income elasticity. Low quality goods have negative income elasticity, as people stop buying them when they can afford to.
There are three types of income elasticity:
a) Zero income elasticity: Here a change in income will have no effect of quantity demanded. For example: – salt, matches, cigarettes.
b) Negative income elasticity: Here an increase in income leads to a decrease in quantity demanded. This happens in inferior goods.
c) Positive income elasticity: In this an increase in income will leads to an increase in quantity demanded. For most goods income elasticity is positive.
3. Cross elasticity (ED):
This measures the change in demand for a commodity due to change in price of another commodity.
ED= Percentage change in quantity demanded of commodity A/ Percentage change in price of commodity B
If the goods having substitutes the cross elasticity is positive i.e. an increase in the price of X will result in an increase in sales of Y. If the goods are complementary and increase in the price of one commodity will depress the demand for the other. So cross elasticity will be negative. If the goods are unrelated cross elasticity will be zero. Because however much the price of one commodity increased demand for the other will not be affected by that increase. There exist another two types of cross elasticity viz.
Advertisement elasticity and Elasticity of price expectation
a) Advertisement elasticity or Promotional elasticity:
The expenditure on advertisement and other sales promotion activities does help in promoting sales, but not in the same degree at all levels of the total sales. The concept of advertisement elasticity is useful in determining the optimum level of advertisement expenditure. It may be defined as, “the responsiveness of demand t to changes in advertising or other promotional expenses”.
EA = Proportionate change in sales/ Proportionate change in advertising and other promotional expenditure
b) Elasticity of price expectations:
The price expectation elasticity refers to the expected change in future price as a result of change in current price of a product.
Where Pc and Pf are current and future price. The coefficient ex gives the measures of expected percentage change in future price as a result of 1 percent change in present price. If ex > 1 it indicates the future change in price will be greater than the present change in price. If ex=1, it indicates that the future change in price will be equal to the change in current price. In ex > 1, the sellers will sell more in the future at higher prices.
Degrees of Elasticity of Demand
Since the responsiveness of quantity demanded varies from commodity to commodity and from market to market, it is important to study the degrees of price elasticity. We can identify five degrees of elasticity. They are:
1. Perfectly elastic demand
2. Perfectly inelastic demand
3. Unitary elastic demand
4. Relatively elastic demand
5. Relatively inelastic demand
1. Perfectly elastic demand:
Perfectly elastic demand is the situation where a small change in price causes a substantial change in quantity demanded i.e. a slight decline in price causes an infinite increase in quantity demanded and a slight increase in price leads to demand contracting to zero. The demand is hypersensitive and the elasticity of demand is infinite.
2. Perfectly inelastic demand:
It is the situation where changes in price cause no change in quantity demanded. Quantity demanded is non-responsive or inelastic.
3. Unitary elastic demand:
It refers to that situation where a given proportionate change in price is accompanied by an equally proportionate change in quantity demanded. For example, if price changes by 10%, quantity demanded also changes by 10%. Ep= 10/10 = 1
4. Relatively elastic demand:
Demand is said to be relatively elastic when a given proportionate change in Price causes a more than proportionate change in quantity demanded.
5. Relatively Inelastic demand:
Demand is relatively inelastic when a given proportionate change in price causes a less than proportionate change in quantity demanded. Demand curve will be a very steep curve. Elasticity is less than 1. For example, If price changes by 20% quantity demanded changes by 10% Then Ep = 10/20 = .5 i.e; Ep<1.
Of the five degrees of elasticity perfectly elastic and perfectly inelastic are extreme cases i.e. rarely found in actual life. Unitary elasticity, relatively elastic and relatively inelastic demand are the most widely used price elasticity.
Factors influencing Price Elasticity of Demand
1. Nature of commodity: Elasticity depends on whether the commodity is a necessity, comfort or luxury. Necessities of life have inelastic demand and comforts and luxuries have elastic demand.
2. Availability of substitutes: Goods with substitutes have elastic demand and goods without substitutes have inelastic demand. For example: coffee and tea are substitutes. If price of tea increases, people may switch over to coffee. If price of coffee raises people may shift to tea. The demand of salt is inelastic.
3. Uses of the commodity: Certain goods can be put to many uses. Example – electricity. Such goods have elastic demand because as the price decreases, they will be put to more uses.
4. Proportion of income spent on commodity: For some goods, consumers spend only a small part of their income. The demand will be inelastic. For e.g.: – salt and matches
5. Price of goods: Generally cheap goods have inelastic demand and expensive goods have elastic demand.
6. Income of consumers: Very rich people have inelastic demand for goods and poor people have elastic demand. Because rich people will buy the commodity at all levels of prices where poor people there is a change in quantity of consumption according to change in price.
7. Time period: Elasticity would be more in the long run than in the short run. Because in the long run consumers can adjust their demand by switching over to cheaper substitutes. Production of cheaper substitutes is possible only in the long run.
8. Distribution of income and wealth in the society: If there is unequal distribution of income, the demand of commodities will be relatively inelastic. If the distribution of income and wealth in the society is equal there will be elastic demand for commodities.