Concept of Elasticity of Demand

Concept of Elasticity of Demand

Elasticity of Demand is a measure of the responsiveness of quantity demanded to changes in price. It is an important concept in economics as it helps to understand how much the quantity demanded of a good or service will change in response to a change in its price.

Elasticity of demand has important implications for businesses and policymakers. In the case of elastic demand, a small change in price can lead to a large change in the quantity demanded. Hence, a business may choose to decrease the price of its product to increase its revenue. On the other hand, in the case of inelastic demand, a change in price does not have much effect on the quantity demanded. Hence, businesses may be able to increase the price of their products without a significant decrease in the quantity demanded. Policymakers can also use the concept of elasticity of demand to determine the impact of taxes and subsidies on the market.

Types of Elasticity of Demand

There are several types of elasticity of demand, which measure the responsiveness of quantity demanded to changes in different variables. Three main types of elasticity of demand are:

1. Price Elasticity of Demand (PED): This measures the responsiveness of quantity demanded to changes in the price of a good or service. It is calculated as the percentage change in quantity demanded divided by the percentage change in price. A good or service is considered to be elastic if its PED is greater than 1, which means that a small change in price leads to a large change in quantity demanded. Inelastic goods or services have a PED less than 1, which means that a change in price leads to a relatively small change in quantity demanded.
2. Income Elasticity of Demand (YED): This measures the responsiveness of quantity demanded to changes in consumer income. It is calculated as the percentage change in quantity demanded divided by the percentage change in income. A good or service is considered to be a normal good if its YED is positive, which means that as consumer income increases, demand for the good or service also increases. A good or service is considered to be an inferior good if its YED is negative, which means that as consumer income increases, demand for the good or service decreases.
3. Cross-Price Elasticity of Demand (XED): This measures the responsiveness of quantity demanded of one good or service to changes in the price of another good or service. It is calculated as the percentage change in quantity demanded of one good or service divided by the percentage change in price of another good or service. A positive XED indicates that the two goods or services are substitutes, meaning that an increase in the price of one good or service leads to an increase in the quantity demanded of the other good or service. A negative XED indicates that the two goods or services are complements, meaning that an increase in the price of one good or service leads to a decrease in the quantity demanded of the other good or service. A zero XED indicates that the two goods or services are unrelated, meaning that a change in the price of one good or service has no effect on the quantity demanded of the other good or service.

Measurement of Price Elasticity of Demand

There are several methods to measure Price Elasticity of Demand (PED), and two of them are the Outlay Method and the Total Point Method.

1. The Outlay Method: The Outlay Method calculates PED by examining the total amount spent by consumers on a good before and after a change in price. The Outlay Method formula is:

PED = (Percentage change in Quantity Demanded / Percentage change in Total Outlay)

Total Outlay is defined as the product of the price and quantity demanded. This method is useful when a change in price causes a change in total revenue for the seller.

2. The Total Point Method: The Total Point Method calculates PED by comparing the initial price and quantity demanded with a new price and quantity demanded at a different point along the demand curve. The Total Point Method formula is:

PED = (Percentage change in Quantity Demanded / Percentage change in Price)

This method is useful when the elasticity of demand is needed for a specific price range.