Elasticity

The degree to which a demand or supply curve reacts to a change in price is the curve's elasticity. Elasticity varies among products because some products may be more essential to the consumer. Products that are necessities are more insensitive to price changes because consumers would continue buying these products despite price increases. Conversely, a price increase of a good or service that is considered less of a necessity will deter more consumers because the opportunity cost of buying the product will become too high. A good or service is considered to be highly elastic if a slight change in price leads to a sharp change in the quantity demanded or supplied. Usually these kinds of products are readily available in the market and a person may not necessarily need them in his or her daily life. On the other hand, an inelastic good or service is one in which changes in price witness only modest changes in the quantity demanded or supplied, if any at all. These goods tend to be things that are more of a necessity to the consumer in his or her daily life. To determine the elasticity of the supply or demand curves, we can use this simple equation: Elasticity = (% change in quantity / % change in price) If elasticity is greater than or equal to one, the curve is considered to be elastic. If it is less than one, the curve is said to be inelastic.

Meanwhile, inelastic demand is represented with a much more upright curve as quantity changes little with a large movement in price.

As we mentioned previously, the demand curve is a negative slope, and if there is a large decrease in the quantity demanded with a small increase in price, the demand curve looks flatter, or more horizontal. This flatter curve means that the good or service in question is elastic.

Elasticity of demand
Elasticity of demand is a demand relationship in which any given percentage change in price will result in a larger percentage change in the quantity demanded. The more demand expands or contracts after a price change the greater the elasticity. It represents responsiveness of the demand for a goods or service to the increase or decrease in its price. Normally, sales increase with drop in prices and decrease with rise in prices. As a general rule, appliances, cars, confectionary and other non-essentials show elasticity of demand whereas most necessities (food, medicine, basic clothing) show inelasticity of demand (do not sell significantly more or less with changes in price). For example, if a 'goods' has a close substitute such as chicken substituted for steak the steak is 'elastic. If the price for steak goes up consumers can choose something else to satisfy their dinner meal. However to fully understand elasticity of demand an example of inelasticity of demand is needed. Milk is usually said to be inelastic because there is no close substitute. (It is true there is powdered and condensed milk but these 'goods' are not powerful enough to affect demand for milk) If the price of a gallon of milk goes up consumers will still purchase the milk. Usually consumer reasoning boils down to a decision about luxury verses necessity.

Factors determining elasticity of demand

(i) Nature of Commodities. In developing countries of the world, the per capital income of the people is generally low. They spend a greater amount of their income on the purchase of necessaries of life such as wheat, milk, course cloth etc. They have to purchase these commodities whatever be their price. The demand for goods of necessities is, therefore, less elastic or inelastic. The demand for luxury goods, on the other hand is greatly elastic. For example, if the price of burger falls, its demand in the cities will go up. (ii) Availability of substitutes. If a good has greater number of close substitutes available in the market, the demand for the good will be greatly elastic. For examples, if the price of Coca Cola rises in the market, people will switch over to the consumption of Pepsi Cola. which is its close substitute. So the demand for Coca Cola is elastic. (iii) Proportion of the income spent on the good. If the proportion of income spent on the purchase of a good is very small, the demand for such a good will be inelastic. For example, if the price of a box of matches or salt rises by 50%, it will not affect the consumers demand for these goods. The demand for salt, maker box therefore will be inelastic. On the other hand, if the price of a car rises from $6 lakh to $9 lakh and it takes a greater portion of the income of the consumers, its demand would fall. The demand for car is, therefore, elastic. (iv) Level of price: The very highly priced items like diamonds and low priced items like pencils have low price elasticity of demand as change in their prices has very little effect on their consumers. (v) Time. The period of time plays an important role in shaping the demand curve. In the short run, when the consumption of a good cannot be postponed, its demand will be less elastic. In the long run if the rise price persists, people will find out methods to reduce the consumption of goods. So the demand for a good in the, long runs are elastic, other things remaining constant. For example if the price of electricity goes up, it is very difficult to cut back its consumption in the short run. However, if the rise in price persists, people will plan substitution gas heater, fluorescent bulbs etc. so that they use less electricity. So the electricity of demand will be greater (Ep = > 1) in the long run than in the short run.

(vi) Number of uses of a good. If a good can be put to a number of uses, its demand is greater elastic (Ep > 1). For example, if the price of coal falls, its quantity demanded will rise considerably because demand will be coming from households, industries railways etc. (vii) Addition. If a product is habit forming say for example, cigarette, the rise in its price would not induce much change in demand. The demand for habit forming- good is, therefore, less elastic. (viii) Joint demand. If two goods are Jointly demand, then the elasticity of demand depends upon the elasticity of demand of the other Jointly demanded good. For example, with the rise in price of cars, its demand is slightly affected, then the demand for petrol will also be less elastic.

Five cases of Elasticity of Demand

Elastic- ( E>1 ) The demand for an item/good is strongly affected by the change in price. This is where a change in a price causes a proportionately smaller change in the quantity demanded. In this case the value of elasticity will be greater than 1, since we are dividing larger figure by smaller figure

Inelastic- (E<1) this is where a change in a price causes a proportionately smaller change in the quantity demanded. In this case elasticity will be less than 1, since we are dividing a larger figure by a smaller figure. The demand for an item is relatively unaffected by the change in price. For example, luxury items on a gasoline.

Unit Elastic - Describes a demand curve which is perfectly responsive to changes in price. That is, the quantity supplied or demanded changes according to the same percentage as the change in price. A curve with an elasticity of 1 is unit elastic. Not really any real life examples

Perfectly Elastic: (E = ) An elasticity alternative in which infinitesimally small changes in one variable (usually price) cause infinitely large changes in another variable (usually quantity). Quantity is infinitely responsive to price. Any change in price, no matter how small, triggers an infinite change in quantity. If the negative sign is not ignored, then the price elasticity of demand is given by E = -.

Perfectly Inelastic (E = 0):

Concepts of elasticity of demand 1. Price elasticity of demand 2. Cross elasticity of demand

3. Income elasticity of demand

4. Advertisement elasticity of demand 5. Elasticity of price expectation

Price Elasticity of Demand Price elasticity of demand (PED) is defined as the responsiveness of the quantity demanded of a good or service to a change in its price. In other words, it is percentage change of quantity demanded by the percentage change in price of the same commodity. In economics and business studies, the price elasticity of demand is a measure of the sensitivity of quantity demanded to changes in price. It is measured as elasticity that is it measures the relationship as the ratio of percentage changes between quantity demanded of a good and changes in its price. Price elasticity is almost always negative, although analysts tend to ignore the sign. Only goods which do not conform the law of demand, such as Veblen and Giffen goods have a positive PED. In simpler words: demand for a product can be said to be very inelastic if consumers will pay almost any price for the product, while demand for a product may be elastic if consumers will only pay a certain price, or a narrow range of prices, for the product. Inelastic demand means a producer can raise prices without much hurting demand for its product, and elastic demand means that consumers are sensitive to the price at which a product is sold and will not buy it if the price rises by what they consider too much. Drinking water is a good example of a good that has inelastic characteristics - in that people will pay anything for it. On the other hand, demand for sugar is very elastic because as the price of sugar increases there are many substitute goods which consumers may switch to. Various research methods are used to calculate price elasticity, including test markets, analysis of historical sales data and conjoint analysis. Determinants of price elasticity of demand: A number of factors can affect the elasticity of a good: Substitutes: The more substitutes, the higher the elasticity, as people can easily switch from one good to another if a minor price change is made Percentage of income: The higher the percentage that the product's price is of the consumer's income, the higher the elasticity, as people will be careful with purchasing the good because of its cost

Necessities versus Luxuries: The more necessary a good is, the lower the elasticity, as people will attempt to buy it no matter the price, such as the case of insulin for those that need it. Duration: The longer a price change holds, the higher the elasticity, as more and more people will stop demanding the goods (i.e. if you go to the supermarket and find that blueberries have doubled in price, you'll buy it because you need it this time, but next time you won't, unless the price drops back down again) Breadth of definition: The broader the definition, the lower the elasticity. For example, Company X's fried dumplings will have a relatively high elasticity, whereas food in general will have an extremely low elasticity. Demand tends to be more elastic:

The larger the number of close substitutes. If the good is a luxury. The more narrowly defined the market. The longer the time period.

The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price.

P e r c e c n h t a ng q ge u e a d in ne t m t y a n i r i c te i c e i l t da y es om =f a n d P e r c e c n h t a ng p ge r e i c i e n

e d

The above formula usually yields a negative value, due to the inverse nature of the relationship between price and quantity demanded, as described by the "law of demand" Income elasticity of demand In economics, income elasticity of demand measures the responsiveness of the demand for a good to a change in the income of the people demanding the good. It is calculated as the ratio of the percentage change in demand to the percentage change in income

A negative income elasticity of demand is associated with inferior goods; an increase in income will lead to a fall in the demand and may lead to changes to more luxurious substitutes.

A positive income elasticity of demand is associated with normal goods; an increase in income will lead to a rise in demand. If income elasticity of demand of a commodity is less than 1, it is a necessity good. If the elasticity of demand is greater than 1, it is a luxury good or a superior good.

A zero income elasticity (or inelastic) demand occurs when an increase in income is not associated with a change in the demand of a good. These would be sticky goods.

Cross Elasticity of Demand Here, a change in the price of one good causes a change in the demand for another. Cross elasticity of Demand For X and Y = This type of elasticity arises in the case of inter-related goods such as substitutes and complementary goods. The two commodities will be complementary, if a fall in the price of Y increases the demand for X and conversely, if a rise in the price of one commodity decreases the demand for the other. They will be substitute or rival goods if a reduction in the price of Y decreases the demand for X, and also if a rise in price of one commodity (say tea) increases the demand for the other commodity (say coffee). The cross elasticity of complementary goods is positive and that between substitutes, it is negative. It should, however, be remembered that cross elasticity will indicate complementarities or rivalry only if the commodities in question figure in the family budget in small proportions. Cross elasticity of demand can be used to indicate boundaries between industries. Goods with high cross elasticity constitute one industry, whereas goods with low cross elasticity constitute different industries. It is not to be supposed that cross elasticity represents reciprocal relationship. It is not a two-way street. The cross elasticity of a tea with respect to coffee is not the same as that of coffee with respect to tea. The tastes of the consumer, his money income and all prices except of the commodity Y are assumed to remain constant.

Relationship between Price Elasticity, Income Elasticity and Substitution Elasticity As Price is depended on income and substitution effect similarly Price Elasticity is depended on Income Elasticity and Substitution Elasticity. This relationship can be represented by

Where, = price elasticity of demand = income elasticity of demand = substitution elasticity of demand = the proportion of the consumers income spent on commodity X

Importance of Elasticity of Demand: (1) Theoretical Importance: The concept of elasticity of demand is very useful as it has got both theoretical and practical advantages. As regards its importance in the academic interest, the concept, is very helpful in the theory of value. In the words of Keynes. "the concept" of elasticity is so important that in the provision of terminology and apparatus to aid thought, I do not think, Marshall did any greater service than by the explicit introduction of the idea of the elasticity. (2) Practical Importance: (i) Importance in taxation policy. As regards its practical advantages, the concept has immense importance in the sphere of government finance. When a finance minister levies a tax on a certain commodity, he has to see whether the demand for that commodity is elastic or inelastic. If the demand is inelastic, he can increase the tax and thus can collect larger revenue. But if the demand of a commodity is elastic, he is not in a position to increase the rate of a tax. If he does so, the demand for that commodity will be, calculated and the total revenue reduced. (ii) Price discrimination by monopolist. If the monopolist finds that the demand for his commodities is inelastic, he will at once fix the price at a higher level in order to maximize his net profit. In case of elastic demand, he will lower the price in order to increase, his sale and derive the maximum net profit. Thus we find that the monopolists also get practical advantages fromthe concept of elasticity. (iii) Price discrimination in cases of joint supply. The-concept of elasticity is of great practical advantage where the separate, costs of Joint products cannot be measured. Here again the prices are fixed on the principle. "What the traffic will bear" as is being done in the railway rates and fares. (iv) Importance to businessmen. The concept of elasticity is of great importance to businessmen. When the demand of a good is elastic, they increases sale by towering its price. In case the demand' is inelastic, they are then in a position to charge higher price for a commodity.

(v) Help to trade unions. The trade unions can raise the wages of the labor in an industry where the demand of the product is relatively inelastic. On the other hand, if the demand, for product is relatively elastic, the trade unions cannot press for higher wages. (vi) Use in international trade. The term of trade between two countries are based on the elasticity of demand of the traded goods. (vii) Determination of rate of foreign exchange. The rate of foreign exchange is also considered on the elasticity of imports and exports of a country. . (viii) Guideline to the producers. The concept of elasticity provides a guideline to the producers for the amount to be spent on advertisement. If the demand for a commodity is elastic, the producers shall have to spend large sums of money on advertisements for increasing the sales. (ix) Use in factor pricing. The factors of production which have inelastic demand can obtain a higher price in the market then those which have elastic demand. This concept explains the reason of variation in factor pricing. Applications The concept of elasticity has an extraordinarily wide range of applications in economics. In particular, an understanding of elasticity is fundamental in understanding the response of supply and demand in a market. Some common uses of elasticity include:

Effect of changing price on firm revenue. Analysis of incidence of the tax burden and other government policies. Income elasticity of demand can be used as an indicator of industry health, future consumption patterns and as a guide to firms investment decisions. Effect of international trade and terms of trade effects. Analysis of consumption and saving behavior. Analysis of advertising on consumer demand for particular goods.

The concept is of very great importance in changing the price of the products having substitutes and complementary goods.

In demand forecasting Helps in measuring interdependence of price of commodity. Multiproduct firms use these concept to measure the effect of change in price of one product on the demand of their other product

In production planning and management In forecasting demand when change in consumers income is expected In classifying goods as normal and inferior In expansion and contraction of the firm by the figure of income elasticity of demand

Markets situations could be studied with the help of IED The concept is helpful in taking Business Decisions Importance of the concept in formatting Tax Policy of the government For determining the rewards of the Factors of Production To determine the Terms of Trades Between the Two Countries Determination of Rates of Foreign Exchange For Nationalization of Certain Industries In economic Analysis, the concept of price elasticity of demand helps in explaining the irony of poverty in the midst of plenty.