ELASTICITY OF DEMAND

ELASTICITY OF DEMAND

Elasticity is a measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants. Economists usually refer to the coefficient of elasticity as the price elasticity of demand, a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in the quantity demanded divided by the percentage change in price. Other coefficients of elasticity may relate to 'income elasticity of demand', 'cross-elasticity of demand',

What Is Price Elasticity of Demand?

Price elasticity of demand is an economic measure of the change in the quantity demanded or purchased of a product in relation to its price change. Expressed mathematically, it is:

Price Elasticity of Demand = % Change in Quantity Demanded / % 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 degrees 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

Ey = Percentage Change in Demand for a product

y = Percentage Change in Incom

More income means more demand vice versa

3) Cross Elasticity of Deman

It is defined as a change in the quantity of demand for one commodity to the change in the quantity of demand to 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.

Cross elasticity of demand formula is as follows

Ec = Proportionate Change in Purchase of Commodity

c = Proportionate Change in the Price of Commodity

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

Ea = Proportionate Change in Demand

a = Proportionate Change in Advertising Expenditure

5) Arc Elasticity

Arc elasticity was introduced very early on by Hugh Dalton. It is very similar to an ordinary elasticity problem, but it adds in the index number problem. Arc Elasticity is a second solution to the asymmetry problem of having an elasticity dependent on which of the two given points on a demand curve is chosen as the "original" point will and which as the "new" one is to compute the percentage change in P and Q relative to the average of the two prices and the average of the two quantities, rather than just the change relative to one point or the other. Loosely speaking, this gives an "average" elasticity for the section of the actual demand curve i.e. the arc of the curve between the two points. As a result, this measure is known as the arc elasticity, in this case with respect to the price of the good.

This method for computing the price elasticity is also known as the "midpoints formula", because the average price and average quantity are the coordinates of the midpoint of the straight line between the two given points. This formula is an application of the midpoint method. However, because this formula implicitly assumes the section of the demand curve between those points is linear, the greater the curvature of the actual demand curve is over that range, the worse this approximation of its elasticity will be.

IMPORTANCE OF ELASTICITY OF DEMAND

1. Price discrimination

If the demand for a product has different elasticities in different markets, then the monopolist can fix different prices in different markets. This price discrimination is possible due to different price elasticities.

2. Levy of taxes

The government will get higher revenue if tax is increased on goods having inelastic demand. Conversely, the government, will get lower revenue if tax is increased on goods having elastic demand.

Terms of trade refer to the rate at which domestic commodities are exchanged for foreign commodities. The terms of trade will be favourable to a country if its exports enjoy inelastic demand in the world market.

4. Determination of volume of output

Volume of goods and services must be produced in accordance with the demand for the commodity. When the demand is inelastic, the producer will produce more goods to take the advantage of higher prices. Hence the nature of elastic and inelastic demand helps in the determination of the volume of output.

5. Fixation of wages for labourers

If the demand for workers is inelastic, efforts of trade unions to raise wages of the workers will be successful. On the other hand, if the demand for labour is elastic, they may not succeed in increasing the wage rate by trade union activity.

HISTORY OF ELASTICITY OF DEMAND

Together with the concept of an economic "elasticity" coefficient, Alfred Marshall is credited with defining "elasticity of demand" in Principles of Economics, published in 1890. Alfred Marshall invented price elasticity of demand only four years after he had invented the concept of elasticity. He used Cournot's basic creating of the demand curve to get the equation for price elasticity of demand. He described price elasticity of demand as thus: "And we may say generally: the elasticity (or responsiveness) of demand in a market is great or small according as the amount demanded increases much or little for a given fall in price, and diminishes much or little for a given rise in price". He reasons this since "the only universal law as to a person's desire for a commodity is that it diminishes; but this diminution may be slow or rapid. If it is slow a small fall in price will cause are going b comparatively large increase in his purchases. But if it is rapid, a small fall in price will cause only a very small increase in his purchases. In the former case, the elasticity of his wants, we may say, is great. In the latter case... the elasticity of his demand is small." Mathematically, the Marshallian PED was based on a point-price definition, using differential calculus to calculate elasticities.