Elasticity of Demand

Meaning
• Elasticity: Quantitative Responsiveness of the dependent variable because of
change in the independent variable.
(a) Price of commodity X reduces from Rs.500 to Rs.400 and the quantity
demanded increases from 100 units to 150 units.
(b) As a result of fall in price of commodity Y from Rs.20 to Rs.18, its quantity
demanded increases from 500 kgs to 520 kgs.
(c) When price of commodity Z falls from Rs.9 to Rs.7.5, the quantity demanded
increases from 1000 Lts to 1005 Lts.
Common amongst these:
• Demand is responding to the change in price. (Quality)
• To what extent (quantitative assessment of the response is Elasticity)
Definition
• Elasticity is defined as the responsiveness of the quantity demanded of a good
(dependent variable) to changes in one of the variables on which the demand
depends (independent variable).
• Most commonly, elasticity of demand refers to the price elasticity.
Price Elasticity
• It is the percentage change in quantity demanded because of percentage change in
price.

• Price Elasticity (Ep)= %change in quantity demanded/ %change in price

(or)
Change in quantity/ Original quantity X 100
Change in price/Original price

• An elastic demand is one in which the change in quantity demanded due to a

change in price is large.
• An inelastic demand is one in which the change in quantity demanded due to a
change in price is small.
• Symbolically,

• Since price and demand have a inverse relationship, the price elasticity will have a
negative sign.
• However, for interpretation, the negative sign is ignored.
• Explanation: If 1% change in price of X causes 2% change in demand of A and
4% change in demand of B, we conclude that demand for B is more elastic to price
changes as compared to A.
• If the negative sign would be considered, it would mean that demand for A is more
elastic, which is incorrect.
Degrees
1) Elastic Demand (Ep>1):
• A change in price results in a large change in quantity demanded.
• An example of products with an elastic demand is consumer durables. These are
items that are purchased infrequently, like a washing machine or an automobile,
and can be postponed if price rises.
2) Inelastic Demand (Ep<1):
• A change in price results in only a small change in quantity demanded. In other
words, the quantity demanded is not very responsive to changes in price.
• Examples of this are necessities like food and fuel. Consumers will not reduce
their food purchases if food prices rise.
3) Unitary Elasticity (Ep=1):
• Change in price is same as the change in quantity demanded.
• This means that a one percent change in quantity occurs for every one percent
change in price.
4) Perfectly Elastic (Ep=∞)
• When a small price reduction or even no change in the prices, raises the demand
from zero to infinity.
• In such situations, the consumer will stop buying from the seller, even if the prices
are increased slightly (perfectly competitive markets).
• This situation is likely to prevail whenever an acceptable rival product is available
at the going price.
• In cases in which no one will pay more than the going price, the seller will lose all
of the existing customers if the prices are raised even by a small fraction.
5) Perfectly Inelastic (Ep=0)
• When there is no change in the quantity demanded, even when the price changes
significantly.
• The quantity demanded does not respond to the price changes.
• Vertical demand curves occur when a commodity is very inexpensive.
• For example: rubber bands, nails etc.
• The demand curve may also be vertical when consumers consider the item in
question to be an absolute necessity. For example: Medicines and life saving drugs
Methods of Measuring Price Elasticity
• Formula for calculating price elasticity=
% change in quantity demanded/ % change in price
Eg. Price of a commodity rises from Rs.6 to Rs.8 and as a result the quantity
demanded reduces from 120 units to 90 units. Ep will be-
= % change in quantity demanded: 25%
=% change in price: 33.33%
Ep= .75
If in the same case, price falls from Rs.8 to Rs.6 and resultantly the quantity
demanded increases from 90 units to 120 units, then:
=% change in quantity demanded: 33.33%
=% change in price: 25%
Ep=1.33
• It thus follows that for the same absolute change in the price and quantity
demanded, different values of price elasticity are derived using different base or
original values for calculating the % changes.
• Therefore, to avoid this, MIDPOINT METHOD is used for calculating the values.
• Midpoint Method: the percentage change in price and quantity demanded are
calculated by taking the mid points of initial values of price and quantity
demanded.
• Eg: Midpoint of prices= 6+8 =7
2
Midpoint of quantity demanded= 120+90 = 105
2
% change in quantity demanded= 28.57%
% change in price= 28.57%
Ep=1
Eg.
1) A consumer purchases 80 units of a commodity when its price is Re.1 p.u. and
purchases 48 units of a commodity when its price rises to Rs.2 p.u.
Calculate the price elasticity of demand for the commodity using the Mid Point
Method?

2) A textile cloth seller lowers the prices of his cloths from Rs.150 per meter to
Rs.142.5 per meter. The present sales are 2000 meters per month and it is estimated
that the price elasticity of demand for the product is 0.7. Calculate:
a) Whether the TR will increase as a result of the price reduction.
b) What will be the TR after price reduction?