Elasticity of Demand and Types of Price Elasticity of Demand
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Concept of Elasticity of Demand
The elasticity of demand is a measure of degree of responsiveness of quantity demanded for a product to the change in its determinants.
The law of demand helps to understand the direction in which price and quantity demanded change.
It is limited to the statement as:
If price increases, quantity demanded will decline or if income rises demand will increase.
But it cannot answer by how much?
In business or economic analysis, it is essential to address ‘by how much’ question.
It is necessary to find out the exact value of the change in quantity demanded in response to the change in price or income.
Elasticity of demand helps to find out the exact values in such cases.
The elasticity of demand is a measure of degree of responsiveness of demand for a product to the change in its determinants.
Elasticity of demand (Ep) = Percentage change in quantity demand for a good ÷ Percentage change in its price
Demand is determined by various factors such as price, income, price of other goods, taste, preferences etc.
There are various types of elasticity of demand as its determinants.
However, we discuss only price, income and cross elasticity of demand as they are the main determinants of demand whose change is visible and measurable.
Types of Elasticity of Demand
There are three types of elasticity of demand; they are:
Price elasticity of demand
Income elasticity of demand
Cross elasticity of demand
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Formula of Price Elasticity of Demand
When price of a good changes; its quantity demanded also changes.
Price elasticity of demand measures by how much quantity demanded for the good changes with a given change in price of it.
So, price elasticity of demand is the measure of reaction of demand for a product to the change in its price being other things constant.
It is defined as percentage change in quantity demanded for a product divided by the percentage change in its price.
The price elasticity of demand is symbolized by the letter Ep; it is written as:
Where,
Q = Initial Quantity demanded
P = Initial Price
ΔQ = Q2 – Q1
ΔP = P2 – P1
Δ = change
The term ‘other things’, refers to the income of consumer, prices of related goods, taste and preferences of the consumer etc.
Price elasticity of demand is a unit free measurement.
It is always expressed in terms of ratio or percentage.
Because of that it facilitates the comparison of change in values measured in different scales.
The value of price elasticity of demand remains always negative.
Because of the negative slope of the demand curve, the price and the quantity demanded will always change in opposite directions.
One change will be positive and the other negative, making the measured elasticity of demand negative.
The value of price elasticity of demand ranges from zero to minus infinity.
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Types or Degrees of Price Elasticity of Demand
Based on the values, elasticity of demand is categorized into five categories.
They are perfectly elastic demand, perfectly inelastic demand, relatively elastic demand, relatively inelastic demand and unitary elastic demand.
They are described below:
(1) Perfectly Elastic Demand (Ep = ∞)
If a very small (insignificant) change in price of a good leads to an infinite (huge) change in quantity demanded for that good, then the demand is known as perfectly elastic demand.
In this types of demand, the value of price elasticity of demand reaches a infinity.
Graphically, in above figure the demand curve is a horizontal straight line and lies parallel to the demand axis.
The demand curve indicates the change in price is insignificant; however, the change in quantity demanded is infinite.
This is an imaginary situation and not found in real market.
(2) Relatively Elastic Demand (Ep > 1)
If percentage change in quantity demand is greater than the percentage change in price of a good, then the demand is known as relatively elastic demand.
At that time 1% change in price leads to more than 1% change in quantity demanded.
In this type of demand the absolute value of price elasticity of demand remains greater than unity.
Graphically, the demand curve will be relatively flatter.
In figure P1Q1 is the original price-quantity combination.
As price declines from p1 to p2, then the quantity demanded increase from Q1 to Q2.
Here, the percentage increase in quantity demanded is greater than the percentage decline in price i.e. ΔQ/Q1>ΔP/p1.
These types of demand can be found in case of luxurious goods such as iPhone, Ferrari Car, Rolex watch etc.
(3) Unitary Elastic Demand (Ep = 1)
If percentage change in quantity demanded is exactly equal to the percentage change in price of good, then the demand is known as unitary elastic demand.
In such type of demand, 1% change in price leads to exactly 1% change in quantity demanded.
At that time, the absolute value of elasticity of demand remains just equal to one.
In the above figure, the P1 and the Q1 are the original price-quantity combination.
As price declines by ΔP/P1 percentage, then the quantity demanded increases by ΔQ/Q1 percentage.
Here, the percentage declines in price is just equal to the percentage increases in quantity demanded i.e. ΔP/P1 = ΔQ/Q1.
These types of elasticity are found basically in normal goods.
(4) Relatively Inelastic Demand (Ep < 1)
If percentage change in quantity demanded is less than the percentage change in price of a good, then the demand is known as relatively inelastic demand.
At that time, 1% change in price leads to less than 1% change in quantity demanded.
In this type of demand the absolute value of price elasticity of demand remains less than unity.
Graphically, the demand curve will be relatively steeper as shown by the line D in figure.
The p1q1 is the original price-quantity combination.
As price declines from P1 to P2 then the quantity demanded increases from Q1 to Q2.
Here, the percentage increase in quantity demanded is less than the percentage decline in price i.e. ΔQ/Q1 < ΔP/P1.
The numerical value of elasticity will be less than unit.
These types of elastic are found in inferior goods.
(5) Perfectly Inelastic Demand (Ep = 0)
If quantity demanded is totally irresponsible to the change in the price of a good, then the demand is known as perfectly inelastic demand.
In such type of demand whatever be the change in price quantity demanded remains the same or unchanged.
These types of elasticity are found in basic necessary goods such as salt, medicines, edible oil etc.
Therefore, the numerical value of elasticity becomes zero.
Graphically, the demand curve shown in figure is a vertical straight line and lies parallel to the price axis.
It indicates demand does not change with the change in price of the good.
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