In the study of Economics, elasticity is a vital concept. With elasticity, a commodity’s changing effect and accordingly its impact on related aspects can be understood. The students must be familiar with it, they are required to grasp the learning right from the root level in order to develop an expert understanding of this subject matter.
Well, so what do you mean by elasticity? What is the use of elasticity? All will be discussed here broadly. Our discussion will be primarily based on the Elasticity of Demand. In this case, we will know about the elasticity of demand, the demand elasticity formula, and other important facets.
What is Elasticity?
Elasticity can be defined as a measure of variable sensitivity to the change in another variable. This sensitivity is the change in price, which is related to change in other factors. From a business and economic point of view, it is a measure of how sensitive an economic factor is to another.
For example, changes in the prices of supply or demand, or changes in demand to changes in income. Examples of elastic goods are clothing and electronics; inelastic goods include items like prescribed drugs, food. It is used to measure the change in quantity demanded of goods or services when compared to the price movements of those goods and services.
What is Elasticity of Demand?
As per the elasticity of demand definition, the demand contracts or extends with rising or fall in the prices. This quality of demand is called Elasticity of Demand when the change in its virtue and the price changes (low or high). The change sensitiveness may be small or less in the elasticity of demand.
Let us take an example to have a better understanding of the concept. If we take salt, even a big fall in demand cannot affect the fall of its appreciable extension in its demand. Similarly, if we observe a slight fall in the prices of oranges, there will be a considerable change in its demand. The elasticity of demand may be more or less, but it is always perfectly elastic or inelastic.
Types of Elasticity of Demand
There are four types of elasticity of demand mainly as given in the following.
1) Price Elasticity of Demand
It is defined as the responsiveness and sensitivity of a particular product along with the changes in its price. It shows the relationship between price and quantity that provides a calculator of the price effect in price quantity of demand.
The below equation calculates the price changes depending on the number of demands and the revenue received by firms before and after any changes.
[E_p = frac{text{Proportionate change in Quantity Demanded}}{text{Proportionate change in Price}} ]
There are different types of price elasticity of demand i.e., 1) perfectly elastic demand, 2) perfectly inelastic demand, 3) relatively elastic demand, 4) relatively inelastic demand, and 5) unitary elastic demand.
2) Income Elasticity of Demand
Income is one of the factors that influence the demand for a product. The degree of responsiveness of a change in demand for the product of the change in demand for the product due to change in income is known as Income elasticity of demand.
[E_y = frac{text{Percentage Change in Demand for a product}}{text{Percentage change in Income}} ]
More income means more demand vice versa.
3) Cross Elasticity of Demand
It is defined as a change in the quantity of demand for one commodity to the change in the quantity of demand for other commodities is called cross elasticity of demand. Usually, this type of demand arises with the involvement of interrelated goods such as substitutes and complementary goods.
[E_c = frac{text{Proportionate Change in Purchase of Commodity X}}{text{Proportionate Change in Purchase of Commodity Y}} ]
For example, if two commodities are called substitutes, when the price of one commodity falls, the demand for another commodity decreases. If the price of one commodity rises in demand, so does the price of another commodity, such as tea and coffee.
4) Advertising Elasticity of Demand
It is defined as the responsiveness of the change in demand to the change in promotional expense is known as the advertising elasticity of demand. It can be expressed by using below the elasticity of demand formula.
[E_c = frac{text{Proportionate Change in Demand}}{text{Proportionate Change in Advertising Expenditure}} ]
Numerically,
[E_a = frac{Q_2 – Q_1}{frac{Q_2 + Q_1}{A_2 – A_1}} times (A_2 + A_1)]
Where,
[Q_1] = Original Demand
[Q_2] = New Demand
[A_1] = Original Advertisement Outlay
[A_2] = New Advertisement Outlay
Solved Example
Q1. What are the two factors that explain the Price Elasticity of Demand? How is it affected by the availability of its close substitutes?
Ans: Many substitutes of goods demand goods that have close substitutes which are relatively elastic, usually when the price of that goods rises the consumers generally shift towards the substitutes. The proportion of income that is spent on the goods in this, then consumer spends a small portion of income mainly on inelastic goods. Therefore, goods on which the consumer spends more will have a lot of elastic demand. Goods that have fewer substitutes like cigarettes will have a completely elastic or inelastic demand.
Did You know?
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There are several factors that influence the law of demand. It tells about the downwards slope of the demand curve mainly it points to when the price falls the demand increases when prices increase the demand decreases.
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In comparison, other things will remain unchanged. There are mainly five effects named as the substitute effect i.e., Income effect, Utility maximizing behavior, a large number of consumers, and varied uses of products.
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For example, if the price of coal is increased, then the demand for the industries which depend on coal will increase and the demand for household purposes will decrease.