The Concept of Elasticity of Demand

Definition of Elasticity of Demand

Elasticity of demand is defined as the degree of responsiveness of demand of a commodity to the change in its determinants

The Concept of Elasticity of demand plays a crucial role in Business Decision making:

Elasticity of demand helps the firms in fixing high prices if the cost of production increases and hence earn higher profits. When cost of production increases the firm will like to pass it to the consumers in the form of increased price of the commodity. Whether raising the price will be beneficial or not will depend upon: The price elasticity of demand for the product. The price elasticity of demand of its substitutes.

Increasing price will be beneficial only if:

Demand for the product is less elastic. Demand for its substitutes is less elastic. Although most businessmen are intuitively aware of the elasticity of demand of the goods they produce, the use of elasticity of demand adds precision to their business decisions.

The concepts of elasticity of demand used in business decision making

Price elasticity of demand Cross elasticity of demand Income elasticity of demand

Price elasticity of demand

Price elasticity of demand is defined as; the degree of responsiveness of demand to the change in its price. or,

ep = % change in quantity demanded

% change in price ep= Q P
P Q

Measurement of elasticity of demand

Graphical Method Point Method Expenditure Method

Graphical Method

Perfectly Elastic Demand (ep= infinity)

Y p r i c e

Q1

Quantity Demanded

Perfectly inelastic demand (ep = 0)

Y p r P1 i c P e O

Q Quantity Demanded

Less Elastic Demand (ep<1)

Y p r i c e

P1 P D O Q1 Q Quantity Demanded X

Relative Elastic Demand

Y p r i P1 c e P D

D O Q Q1 Quantity Demanded X


(ep>1)

Highly Elastic Demand

Y p r i c e D P1 P D

Q1

Quantity Demanded


ep=infinity ep>1 ep=1

Point Elasticity of Demand

Formula :
ep=lower segment upper segment
ep<1

ep=0

Expenditure Method
Elastic Demand ( ep>1) P (Rs.) 6 5 Q (Nos.) 10 13 TE (Rs.) 60 65

Inelastic Demand (ep<1)

P (Rs.) 6 5

Q (Nos.) 10 11

TE (Rs.) 60 55

 Unitary Elastic Demand (ep=1) P (Rs.) 6 5 Q (Nos.) 10 12 TE (Rs.) 60 60

Income elasticity of Demand

Income elasticity of demand is defined as the degree of responsiveness of demand of a commodity towards the change in income of the individual. Formula :

ey= Q Y
Y Q

Cross Elasticity of Demand

The cross elasticity of demand is defined as degree of responsiveness of demand of Commodity X to the change in price of the Commodity Y. Formula : ep= Qx Py Py Q

Determinants of price elasticity of demand

Availability of substitutes Nature of commodity Proportion of income spent Number of uses of commodity Postponement of consumption