Elasticity of Demand | Price Cross Income

Last updated on September 10th, 2022 at 02:35 am

The concept of elasticity of demand refers to the degree of responsiveness of demand of a good to a change in its determinants. Elasticity of Demand

Elasticity of demand

Elasticity of demand differs in case of different commodities. For the same commodity, elasticity of demand differs from person to person. Analysis of elasticity of demand is not limited to price elasticity only, income elasticity of demand and cross elasticity of demand are also important to understand. Elasticity of Demand

Types of Elasticity of Demand

Elasticity of demand is mainly of three types:

• Price Elasticity of Demand
• Cross Price Elasticity of Demand
• Income Elasticity of Demand

Price Elasticity of Demand

Price elasticity of demand refers to the responsiveness of demand to a Change in price of a commodity. It may be noted that the price elasticity of demand has a negative sign because of the negative relationship between price and demand. Here is the price elasticity of demand formula.

The formula for calculating price elasticity is:

Ed = Change in Quantity Demanded / Change in Price

Price elasticity of demand formula.

There are five types of Price Elasticity of Demand depending upon the magnitude of response of demand to a change in price.:

• Perfectly elastic demand
• Perfectly inelastic demand
• Relatively elastic demand
• Relatively inelastic demand
• Unitary elastic demand

Perfectly elastic demand: The demand is said to be perfectly elastic when a very insignificant change in price leads to an infinite change in quantity demanded. A very small fall in price causes demand to rise infinitely.

• (Ed = Infinity)

Likewise a very insignificant rise in price reduces the demand to zero. This case is theoretical which may not be found in real life. The demand curve in such a situation is parallel to X-axis. Numerically, elasticity of demand is said to be equal to infinity.

Perfectly inelastic demand: The demand is said to be perfectly inelastic when a change in price produces no change in the quantity demanded of a commodity. In such a case quantity demanded remains constant regardless of change in price.

• (Ed = 0)

The amount demanded is totally unresponsive to change in price. The demand curve in such a situation is parallel to Y-axis. Numerically, elasticity of demand is said to be equal to zero.

Relatively elastic demand: The demand is relatively more elastic when a smaller change in price causes a greater change in quantity demanded. In such a case a proportionate change in price of a commodity causes more than proportionate change in quantity demanded.

• (Ed> 1)

For example: If price changes by 10% the quantity demanded of the commodity changes by more than 10%. The demand curve in such a situation is relatively flatter. Numerically, elasticity of demand is said to be greater than 1.

Relatively inelastic demand: It is a situation where a greater change in price leads to a smaller change in quantity demanded. The demand is said to be relatively inelastic when a proportionate change in price of a commodity causes less than proportionate change in quantity demanded.

• (Ed< 1)

For example: If price changes by 20% quantity demanded changes by less than 20%. The demand curve in such a case is relatively steeper. Numerically, elasticity of demand is said to be less than 1.

Unitary elastic demand: The demand is said to be unitary elastic when a change in price results in exactly the same percentage change in the quantity demanded of a commodity. In such a situation the percentage change in both the price and the quantity demanded is the same.

• (Ed = 1)

For example: If the price falls by 25%, the quantity demanded also rises by 25%. It takes the shape of a rectangular hyperbola. Numerically, elasticity of demand is said to be equal to 1.

Cross Price Elasticity of Demand

The change in the demand of a good x in response to a change in the price of good y is called ‘cross price elasticity of demand’. Here is the Cross price elasticity of demand formula. Its measure is

Ed = Change in Quantity Demanded of Good X / Change in Price of Good Y

Cross price elasticity of demand formula

• Cross price elasticity may be infinite or zero.
• Cross price elasticity is positive infinity in case of perfect substitutes.
• Cross price elasticity is positive if the change in the price of good Y causes a change in the quantity demanded of good X in the same direction. It is always the case with goods which are substitutes.
• Cross price elasticity is negative if the change in the price of good Y causes a change in the quantity demanded of good X in the opposite direction. It is always the case with goods which are complements of each other.
• Cross price elasticity is zero, if a change in the price of good Y does not affect the quantity demanded of good X. In other words, in case of goods which are not related to each other, cross elasticity of demand is zero.

Cross price elasticity of demand end.

Income Elasticity of Demand

Income Elasticity of Demand According to Stonier and Hague: “Income elasticity of demand shows the way in which a consumer’s purchase of any good changes as a result of change in his income.”

Income Elasticity of Demand shows the responsiveness of a consumer’s purchase of a particular commodity to a change in his income. Income elasticity of demand means the ratio of percentage change in the quantity demanded to the percentage change in income. here is the Income Elasticity of Demand Formula

Income Elasticity of Demand Formula.

Ey = Percentage Change in Quantity Demanded of Good X / Percentage Change in Real Income of Consumer

Income Elasticity of Demand is noteworthy that sign of income elasticity of demand is associated with the nature of the good in question.

Normal Goods: Normal goods have a positive income elasticity of demand so as consumers’ income rises, demand also increases.

Normal necessities have an income elasticity of demand between 0 and 1. For example, if income increases by 10% and the demand for fresh fruit increases by 4%, then the income elasticity is +0.4. Demand is rising less than proportionately to income.

Luxuries have an income elasticity of demand greater than 1, Ed>1.i The demand rises by more than the percentage change in income. For example, an 8% increase in income might lead to a 16% rise in the demand for restaurant meals. The income elasticity of demand in this example is +2. Demand is highly
sensitive to income changes.

Inferior goods: Inferior goods have a negative income elasticity of demand. Demand falls as income rises. For example, as income increases, the demand for higher quality cereals goes up against the low-quality cheap cereals.