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Elasticity of demand
 The elasticity of demand is defined as the rate of
change in quantity demanded for a given change
in price.
 It is primarily related to extension or contraction
of demand for a fall or rise in price.
 Hence, this is called price elasticity of demand.
 But there are other factors which influence
elasticity of demand and accordingly we have
three types of elasticity of demand.
a) price elasticity of demand
b) income elasticity of demand and
c) cross elasticity of demand
Price elasticity of demand
 Price elasticity of demand is the ratio of proportionate
change in the quantity demanded of a given commodity to
a given proportionate change in its price.
 The term ‘E’ gives the coefficient of price elasticity of
demand.
 If E is greater than one, the demand is said to be elastic.
 If E is less than one, the demand is said to be inelastic and
if E is equal to one, the demand is unitary.
 The terms elastic and inelastic are only relative terms.
Based on the elasticity we have five types of demand.
Perfectly of infinitely elastic
demand
 When a small change in price of a good causes
more than a proportionate change (in both ways)
in the quantity it is called perfectly or infinitely
elastic demand.
 The demand curve will be a horizontal line,
parallel to the X- axis in the graph.
Perfectly inelastic demand
 When a change in price causes no change in
quantity, it is called perfectly inelastic demand.
 The demand curve will be a vertical line.
Relatively elastic demand
 When a small change in price causes a big change
in quantity, it is called relatively elastic demand.
 The coefficient of elasticity is more than one. The
demand curve is a downward sloping curve.
Relatively inelastic demand
 When a larger change in price causes a smaller
change in quantity, it is called relatively inelastic
demand.
 The coefficient of elasticity is less than one. The
demand curve will be steeper than the normal
relatively elastic demand curve.
Unit elasticity of demand
 When a change in price causes an exact change in
quantity demanded of a commodity, it is called
unit elasticity of demand.
 The coefficient of elasticity is equal to one. The
demand curve slopes more or less uniformly.
 We generally come across the above types of
demand but the perfectly inelastic and unitary
elastic demand curves are rare.
Measurement of price elasticity
of demand
 Alfred Marshall explains the concept of elasticity
of demand and three methods are used for its
measurement viz, Point method, ARC method and
Total outlay method.
Point Method
 In this method, the elasticity of demand is found
out at a particular point in the demand curve.
 For example, at the middle point of the straight
line demand curve, elasticity is equal to unity at
the higher points of the demand curve, to the left
of the middle point, elasticity is more than unity;
 At lower points, to the right of the middle point
elasticity is less than unity;
 Elasticity is infinity at the point, where the
demand curve coincides with the Y- axis and the
elasticity is zero at the point where the demand
curve coincides with the X-axis.
ARC method
 The point method considers minute changes in
price and demand which is not realistic.
 In reality, we come across demand schedules with
gaps in prices and quantities.
 Hence the point method has become absolute.
 The ARC method is a better method for
measuring demand elasticity using the following
formula.
ARC method
Arc Elasticity of demand =
∆q
÷
∆p
(q1 + q2 )
(p1 + p2)
2
2
Where ∆q = change in quantity
∆p = change in price
q1 = original quantity
q2 = new quantity
p1 = original price
p2 = new price
Total expenditure or outlay
method
 In this method, we consider the change in price
and the consequent change in demand for a
product in relation to the total amount of money
spent by the consumer on the product.
 The drawback of this method is that we may not
know exactly the value of ‘E’ in numerical terms.
The classification can be simply made as elastic
or inelastic or unitary demand
Income elasticity of demand
 The income elasticity of demand is the ratio of
proportionate change in the quantity demanded of a
commodity to a given proportionate change in the
income of the consumer.
Ey =
Percentage change in quantity demanded
Percentage change in income
there,
Ey = income elasticity of demand
 There are five kinds of income elasticity of demand.
Zero income elasticity of demand
 It occurs when a given increase in consumer’s
money income fails to lead to any increase in the
quantity demanded of a commodity
Negative income elasticity of
demand
 It happens when an increase in the consumer’s
money income is accompanied by a fall in the
quantity of goods purchased. It is more relevant to
the inferior goods
Unitary income elasticity of
demand
 When the proportion of the consumer’s income
spent on the goods is exactly the same both before
and after the rise in income, then it is called
unitary income elasticity of demand.
Income elasticity of demand
greater than one
 In this case, the consumer spends a greater
proportion of money income on the commodity as
he/she becomes richer.
Income elasticity of demand less
than one
 It occurs when the proportion of consumer’s
money income spent on the commodity falls when
his/her income increases.
 For example, the expenditure on necessaries do
not increase proportionately with increase in
income.
Cross elasticity of demand
 The degree of change in demand for a product as a
result of change in the price of another product is
known as cross elasticity of demand.
 It shows how the demand for a commodity depends
on the prices of related commodities which may be
substitutes or complements.
 The formula for cross elasticity of demand is as
follows:
Importance of demand elasticity
 The concept of demand elasticity has enormous
significance in economics as it finds application
in production, price fixation, price stabilization,
distribution, international trade, foreign exchange
rate determination and public finance.
 An understanding of elasticity of demand is
required to frame economic policies also.
Engel's law
Consumption is a function of income. Among
others, income and standard of living influence
demand for a commodity.
The Engels of law of consumption, postulated
by Dr. Ernest Engels in 1857, explains
consumption pattern with reference to income.
According to the Engel’s law, as the family
income increases, (i) the percentage
expenditure on food and other necessaries
decreases, (ii) the percentage expenditure
remains almost constant in the case of
clothing, fuel and light and (iii) the percentage
expenditure on comforts and luxuries such as
education, health, recreation, tends to increase.
The law explains that rich people will be
spending smaller percentage of their income
on necessaries of life, while they spend larger
percentage on comforts and luxuries. The key
word in the law is percentage expenditure and
not the absolute expenditure.