Elasticity and Its Measurement
Elasticity:
In economics, the term ‘elasticity means the responsiveness of one variable to changes in another. For example, the price elasticity of demand means the percentage rise or fall in quantity demanded of a good or service resulting from one percentage change in the price of the product, other things remaining constant.
Elasticity of Demand:
Elasticity of demand measures the extent to which the quantity demanded commodity increases or decreases in response to the increase or decrease in any of its determinants.
Price Elasticity of Demand:
Price elasticity of demand relates to the responsiveness of the quantity demanded of a commodity to the change in its price. In other words, the price elasticity of demand is defined as “the percentage change in the quantity demanded divided by the percentage change in the price”.
Ep = Percentage change quantity demanded/percentage change in price
Types of Price Elasticity of Demand
- Perfectly elastic demand (Ep = ∞)
- Perfectly inelastic demand (Ep=0)
- Unitary elastic demand (Ep = 1)
- Relatively elastic demand (Ep > 1)
- Relatively inelastic demand (Ep < 1)
Income Elasticity of Demand:
Income elasticity of demand shows the degree of responsiveness of the quantity demanded a commodity to the change in the income of the consumer. The income elasticity of demand is also defined as the ratio of the percentage change in demand for a commodity to the percentage change in income.
Types of Income Elasticity of Demand
- Positive income elasticity of demand (Ey > 0)
- Income elasticity greater than unity (Ey > 1)
- Income elasticity less than unity (Ey < 1)
- Income elasticity equal to unity (Ev= 1)
- Zero income elasticity (Ey =0)
- Negative income elasticity (Ey < 0)
Cross Elasticity of Demand
Cross elasticity of demand is defined as the responsiveness of the change in demand for a commodity to the change in the price of related commodity. It is also defined as the ratio of the percentage change in demand for a commodity to the percentage change in the price of the related commodity. The cross elasticity of demand between commodity-X and commodity-Y is expressed as,
Exy = Percentage change in demand for commodity-X/Percentage change in price of commodity-Y
Types of Cross Elasticity of Demand
- Positive Cross Elasticity of Demand (Exy> 0)
- Negative Cross Elasticity of Demand (Exy<0)
- Zero Cross Elasticity of Demand (Exy=0)
Measurement of Price Elasticity of Demand
Total Outlay Method: Alfred Marshall developed this method to measure the price elasticity of demand. According to this method, we compare the total outlay of a consumer before and after the variations in price Looking at the change in total expenditure due to the change in price, we can say whether the demand for a commodity is elastic, unitary elastic, or inelastic.
- Elasticity greater than unity (Ep > 1)
- Elasticity less than unity (Ep < 1)
- Elasticity equal to unity (Ep = 1)
Point Method: Point method is also known as the geometric method or graphical method. This method was developed by Alfred Marshall for measuring the price elasticity of demand at a point on a demand curve. Therefore, this method is the measure of price elasticity of demand at a particular point the demand curve. This method is used when very small change in the price of a commodity results in very small change in its quantity demanded. In this case, the price elasticity formula can be expressed as,
EP = Lower segment of the demand curve/Upper segemnt of the demand curve
Determinants of Elasticity of Demand
- Nature of the commodity
- Substitute
- Goods having several uses
- Joint demand
- Income of the consumer
- Postponement of the consumption
- Habits
- Price level
- Time factor
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Elasticity of Supply
Elasticity of supply is defined as the responsiveness of the quantity supplied of a commodity due to the change in its price. It is also defined as the ratio of the percentage change in the quantity supplied and the percentage change in the price of the commodity. Elasticity of supply is also known as the price elasticity of supply. It is expressed as
Es = Percentage change in quantity supplied/Percentage change in price
Types of Elasticity of Supply
- Perfectly elastic supply (E, = 0)
- Perfectly inelastic supply (E, = 0)
- Unitary elastic supply (Ey= 1)
- Relatively elastic supply (E, > 1)
- Relatively inelastic supply (E, < 1)
Meaning of Key Term:
- Complementary goods: Goods that have negative cross elasticity of demand or goods which are needed together in order to fulfill the single desire. For example, sugar, tea, and milk are complementary goods.
- Cross elasticity of demand: Percentage change in demand for one commodity due to the given percentage change in the price of another commodity. It is found only in the case of related goods
- Elasticity: Responsiveness of one variable due to the change in another variable
- Income elasticity of demand: Percentage change in demand for a commodity due to one percentage change in the income of the consumer
- Inferior goods: Goods that have a negative income elasticity of demand for goods whose demand rises with fall in income and vice versa
- Income: The amount of money flow in the form of wages, salaries, interest payments, dividends, and other receipts accruing to an individual or a nation over a specific period of time, usually over one year.
- Neutral goods: Goods that have zero income elasticity of demand or goods whose demand does not change with change in income
- Normal goods: Goods that have positive income elasticity of demand or goods whose demand rises with rising in income and falls with fall in income
- Normal necessities: High-quality necessity goods like meat, fruits, etc. which are demanded more at the higher income and vice versa
- Price elasticity of demand: Percentage change in the quantity demanded due to one percentage change in the price of the commodity
- Price level: Average price of all the goods and services which are consumed in the economy
- Demand curve: Demand curve is defined as the graphical representation of various quantities of a commodity demanded at different prices in a given period of time.
- Supply curve: Supply curve is defined as the graphical representation of various quantities of a commodity supplied by a seller or firm at different prices in a given period of time.
- Substitute goods: Goods that have positive cross elasticity of demand or one can be used in the absence of the other in order to satisfy a similar desire. For example, tea and coffee are substitute goods. Two goods are substitutes if the quantity demanded of one is positively related to the price of the other.
Some Additional Information:
- Elasticity of demand is the measure of the responsiveness of quantity demanded of a product to the change in the value of its determinant.
- Price elasticity of demand is the percentage change in quantity demanded divided by percentage change in price.
- Income elasticity of demand is the percentage change in quantity demanded divided by percentage change in the percentage change in income.
- Cross elasticity of demand is the percentage change in quantity demanded of X commodity divided by the percentage change in the price of Y commodity.
- In total outlay method,
- If total outlay increases due to the fall in price level, then the price elasticity of demand is greater than one.
- If total outlay remains constant although price level change, then the price elasticity of demand is equal to one.
- If total outlay decreases due to the fall in the price level, then the price elasticity of demand is less than one.
