Elasticity of demand(Ed) Elasticity measures the extent to which

demand will change.

Knowing the direction of change in demand is not enough for a
manager. It is important to know to what extent the demand for
his product is going to change with the change in any of the
determinants.
An elasticity is a measure of the sensitivity of one variable to
another.
Specifically, it is a number that tells us the percentage change that
will occur in one variable in response to a percent change in
another variable. It measures the responsiveness of a variable to the
changes in its causal factors.

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 Various Types of Elasticity's
Price Elasticity - measures the sensitivity of quantity demanded to price
changes.
Income Elasticity - measures the sensitivity of quantity demanded to
income changes.
Cross Elasticity- measures the sensitivity of quantity demanded to price
changes of substitute and complementary goods
Advertising/Promotional Elasticity- measures the sensitivity of quantity
demanded to change in advertising expenditures
OBSERVATIONS
When demand is elastic, a decrease in price will result is an increase in the
revenue (sales).
When demand is inelastic, a decrease in price will result is a decrease in the
revenue (sales).
When demand is unit-elastic, an increase (or a decrease) in price will not
change the revenue (sales).
Coefficient of price Terminology Description
Elasticity
Ed = Infinity Perfectly elastic Consumers have infinite
demand at a particular
price or none at all at even
a slightest hike in price

Ed = 0 Perfectly inelastic Demand remains

unchanged at all prices

Ed > 1 Relatively elastic Demand changes by larger

%age than price

Ed <1 Relatively Inelastic Demand changes by

smaller %age than price

Ed = 1 Unitary Elastic Demand changes by equal

%age that of price
Perfectly Inelastic Demand: Elasticity
Equals Zero
Perfectly Elastic Demand: Elasticity
Equals Infinity
Unit Elastic Demand: Elasticity Equals
1
Inelastic Demand: Elasticity Is Less
Than 1/ Relatively Inelastic
Elastic Demand: Elasticity Is Greater
Than 1/ Relatively Elastic
 Measurement of price elasticity of demand
Elasticity of demand can be measured using any one of
the following technique:
(a) Percentage method: here, Ed is measured as
proportionate change in the quantity demanded divide
by per cent change in price of the commodity.
Q / P . P/Q

(b) Graphical/ point method: by visual inspection of the

demand curve, we can estimate the Ed.

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 (c) Total outlay/ expenditure method: here we deal how
the price change affects the total revenue of the firm
through influencing the quantity demanded of that
commodity.

Thumb rule:
i. When change in price and in total revenue are in same
direction(i.e. p rises, TR rises), Ed<1
ii. When the change in price and total revenue are in
opposite direction, then Ed>1
iii. When change in price does not change TR, then Ed=1.

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 Determinants of price elasticity of demand

Greater the number of close substitutes, of the price respectively. more

will be the price-elasticity since whenever there is a change in the price of
the commodity, it will be substituted by and for the substitutes depending
on the increase and decrease
The nature of the commodity used whether luxury or necessity. For
necessities, like food, medicines, etc. the elasticity will be low enough.
Changes in their prices are not going to change quantities demanded
appreciably. For luxuries, on prices e can postpone the consumption.
Share of commodity in buyers budget: if proportion of income to be
spent is small, demand tends to be inelastic. Eg; match boxes, ink, etc.
Time period: longer the time period considered, greater will be the
possibility of substituting the commodity with a cheaper commodity. Thus
demand is more elastic in long run than in short run. Say amount of sugar
demanded in a week, month, year, etc.

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 The durability of goods particularly HH goods like TV, car, washing
machines, etc. also affects the elasticity. These goods are used for longer
periods. If prices fall, there may be considerable replacement activities
causing an increase in the quantity demanded, making elasticity higher.
Number of uses a commodity can be put to: larger the number of uses,
higher will be the elasticity and vice versa.
Range of Price change: Goods having a high price are more elastic as the
slightest hike in its price will lower its demand whereas goods having low
price can still be demanded even with a small hike in its price.
Habit-forming characteristics: like tobacco and alcohol, whose demand
tends to be inelastic.

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 Income Elasticity of demand: it shows the extent to which a consumers
demand for the commodity changes as a result of a change in income.
Ey = Percentage change in the quantity demanded of good X
Percentage change in income of the consumer
Coefficient of Income Terminology Description

Em <0 Negative income elasticity Increase in income causes

decrease in demand of a
product(inferior goods)
Em= 0 Perfectly inelastic Demand remains
unchanged at all income
level
Em> 1 Relatively elastic Demand changes by larger
%age than income
Em <1 Relatively Inelastic Demand changes by
smaller %age than income
Em = 1 Unitary Elastic Demand changes by equal
%age that of income
 When Income Elasticity is positive, the commodity is normal good
When Income Elasticity is negative, the commodity is inferior
good
When Income Elasticity is positive & greater than one, the
commodity is luxury good
When Income Elasticity is positive but less than one, the
commodity is necessity good
When Income Elasticity is zero, the commodity is neutral, i.e.,
demand for salt, match box, etc.
 Cross Elasticity of demand: it is the ratio of the percentage change in
demand for one good to the percentage change in price of some other
related goods.
Ed = % change in demand for tea(product X)
% change in price of coffee(product Y)
If the cross Ed is positive, the products in consideration are substitute
goods
If the cross Ed is negative, the products in consideration are complementary
goods

Advertisement Elasticity of demand: : it is the ratio of the percentage

change in sales for one good to the percentage change in advertisement or
promotional expenditure
Ed = % change in total sales of a product
% change in advertisement expenditure

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 Factors determining advertisement elasticity
For a newly introduced product, demand increases at a lower rate than the rate of
increase in advertisement expenditure.
In a highly competitive market the effectiveness of advertisement is also
determined by relative effectiveness of advertisement by rival firms. Therefore
advertisement by rival firm reduces the sales of another firm
There is a cumulative effect of past advertisement, though initially the elasticity
is very low but considerably it has an increasing elasticity of demand

Uses / Applicability of Elasticity

To Businessman: Decision on pricing policy
When demand of a product is found unitary elastic, price change is ineffective in
bringing more revenue
When demand of a product is more than unitary elastic, price cut leads to
increase in sales more than proportionately
When demand of a product is found inelastic, raising the price will lead to
increase in total revenue
 To Government & Finance Minister: In determining fiscal policy &
taxation policy
Tax imposition is effective in increasing revenue over inelastic goods
More elastic goods will contract with increase in tax.

In International Trade: EXIM Policies

To Policy Makers: setting policies over price cutting, price ceiling, etc.

To Trade Unions: Wage Bargaining

If Demand for labor is elastic, trade union will demand higher wages
If Demand for labor is inelastic, trade union will demand lower wages