Welcome! In our Economics lesson today, we will be discussing “Elasticity of Demand”. Do have a beautiful moment studying with us!
Lesson Note
Subject: Economics
Topic: Elasticity of Demand
Learning Objectives: By the end of the lesson, the learners should be able to:
- Explain the term elasticity of demand and price elasticity of demand;
- State and explain the various types of price elasticity with the aid of diagrams;
- Solve problems relating to calculation of elasticity of demand
- List the factors affecting the elasticity of demand,
- State the importance of elasticity of demand.
Discussions
Elasticity of Demand
Elasticity of demand may be defined as the degree of responsiveness of demand to little changes in the price of a commodity.
Elasticity of demand measures the extent to which the quantity of a commodity demanded by consumers changes as a result of a little change in the price of the commodity.
Closely related to the definition of elasticity of demand are:
I. Price elasticity of demand
II. Income elasticity of demand
III. Cross elasticity of demand
Price Elasticity of Demand
Price elasticity of demand, also known as the co-efficient of price elasticity, may be defined as the degree of responsiveness of demand to little changes in prices of goods and services. In other words, it is the degree of responsiveness of quantity demanded to a small change in the price of the commodity. It is the ratio of the percentage change in quantity demanded to the percentage change in price.
Types of price elasticity of demand
i. Elastic demand: Demand is said to be elastic if a small change in price leads to a greater change in the quantity of goods demanded. In this case, elasticity is greater than one or unitary i.e E = > 1 < infinity. This type of elasticity can also be described as fairly elastic demand. The diagram below illustrates this fact.
Fig i. Elastic or fairly elastic demand
ii. Inelastic demand: Demand is said to be inelastic if a larger change in price leads to a small or slight change in the quantity of goods demanded. In this case, elasticity is less than one but greater than zero, i.e E = >0<1. This type of elasticity can also be described as fairly inelastic demand.
Fig ii. Inelastic demand or fairly inelastic demand
iii. Unity or unitary elastic demand: Demand is said to be unitary when a change in price leads to an equal change in the quantity of goods demanded. In other words, a 5% change in price will lead to a 5% change in demand. In this situation elasticity is equal to one, E = 1.
Fig iii. Unitary or unity elastic demand
iv. Perfectly elastic demand or infinitely elastic demand:
Demand is said to be perfectly elastic when a change in price brings about an infinite effect on the quantity of goods demanded. In other words, a slight increase in price can make consumers to stop the purchase of the commodity while a slight decrease in price will make consumers to purchase all the commodities. In this case, elasticity is equal to infinity.
Fig iv. Perfectly elastic demand or infinitely elastic demand.
Fig iv. Perfectly elastic demand or infinitely elastic demand.
Perfectly inelastic demand or zero elastic demand: Demand is said to be perfectly inelastic if a change in price has no effect whatsoever on the quantity of goods demanded. In other words, the same quantity of goods is demanded irrespective of changes in price. In this case, elasticity is equal to zero, i.e E = 0
Fig v. Perfectly inelastic or zero elastic demand
Measurement of elasticity of demand
Elasticity of demand can be measured or calculated by using co-efficient of price of elasticity of demand. The formula used in calculating the elasticity of demand is:
Elasticity of demand = percentage change in demand / percentage change in price
As earlier explained above, when elasticity is calculated and it is:
(a) equal to one, then elasticity of demand is unity
(b) greater than one, then elasticity of demand is elastic
(c) lesser than one, then elasticity of demand is inelastic
Example 1
The price of bread in 2002 was increased from #40 to #50 and the quantity bought per week by a consumer decreases from 160 loaves to 80.
(a) present the above information in a table
(b) calculate the co-efficient of price elasticity of demand
(c) what type of elasticity is this demand and how did you arrive at your conclusion
Solution
(c) The co-efficient of elasticity of demand is elastic. This is because after calculating the elasticity of demand, it was greater than 1.
Example 2:
Solution
Income elasticity of demand
Income elasticity of demand is defined as the degree of responsiveness of demand to changes in income of consumers. In other words, it measures how changes in income of consumers will affect the quantity of commodities demanded by such consumers. It should be noted that income elasticity of demand is negative for inferior goods since an increase in income will lead to a decreased demand for them.
Measurement of income elasticity of demand
Income elasticity of demand can be measured or calculated by using the co-efficient of income elasticity of demand. Thus, co-efficient of income elasticity of demand.
Income elasticity of demand:
Percentage change in income
Types of income elasticity of demand
i. Positive income elasticity of demand: This is the type of income elasticity of demand in which an increase in income of consumers will equally lead to an increase in the quantity of commodity demanded. This is applicable mainly to normal commodities.
ii. Negative income elasticity of demand: This is the type of income elasticity of demand in which an increase in income of consumers will lead to a decrease in the quantity of commodities demanded. In this case, as income increases, demand for commodities falls. This is applicable to inferior goods.
Worked example
A weekly income of a clerk was increased from #100 to #125 as a result of his promotion in the office. He is able to purchase 300 loaves of bread instead of 200 per week.
(1) Calculate the co-efficient of his income elasticity of demand
(2) Is the demand elastic or inelastic? Why?
(3) What kind of good is bread to the consumer?
Solution
The coefficient of Income elasticity = 2
(2) The co-efficient of elasticity of demand is elastic. It is elastic because elasticity is greater than 1.
(3) The kind of good bread is to the consumer is a normal good because as the income increases, his demand for bread also increases thus indicating a positive type of income elasticity of demand.
Cross elasticity of demand
Cross elasticity of demand may be defined as the degree of responsiveness of demand for a commodity to changes in the price of another commodity. In other words, cross elasticity of demand refers to the proportionate change in the quantity of goods (X) demanded over the proportionate change in the price of another good (Y) demanded.
Cross elasticity of demand is applicable mainly to goods that are close substitutes as well as complementary goods. For example, the demand for butter will increase if there is an increase in the price of margarine.
Measurement of cross elasticity of demand
Cross elasticity of demand can be measured or calculated by using the co-efficient of cross elasticity of demand. Thus, co-efficient of cross elasticity of demand =
Now let us look into this example:
The table below shows the responsibility of of quantity demanded to changes in prices of two pairs of commodities. Use the table to answer the questions that follow.
(1) Calculate the cross elasticity of demand for:
i. Maltina and Maltonic. ii. Close up and Maclean
(2) Are their elasticities elastic or inelastic? State your reason.Solution
%change in the price of close up (Y) is calculated below:
% change in price =
(2) The cross elasticity for Maltina and Maltonic is inelastic because the elasticity which is 0.83 is less than 1.
The cross elasticity for Maclean and Close up is elastic because the elasticity which is 1.25 is greater than 1.
Factors Affecting Elasticity of Demand
i. The income of the consumer: The higher the consumers’ income, the more inelastic his demand for goods and services will tend to be.
ii. Close substitute of a commodity: Commodities which have class substitutes tend to have a high priority elasticity of demand while those that do not have class substitutes are likely to be inelastic.
iii. Nature of commodity: Whether the commodity is a necessity or a luxury item will affect the elasticity of demand. Any item that is considered necessary will always be demanded even if the price is increased, i.e the commodity is inelastic in demand. Lyzury goods on the other hand are highly elastic in demand.
iv. One’s habit: When one forms a habit on the consumption of a commodity, a change in the price of that commodity will not affect one’s demand for it.
v. Number of uses to which a commodity is put: It is known that the more a commodity can be put into several uses, the more elastic the demand becomes and vice versa.
Importance of Elasticity of Demand
i. Increase in Revenue: It helps the producers or sellers to increase their revenue in a bid to raise the prices of their commodities. This will depend on whether their goods are inelastic or elastic.
ii. Determination of maximum output: It also helps the producers to determine the maximum output to produce in order to ensure higher turnout and profit.
iii. Determination of cross elasticity: It helps the producer to determine which goods to produce more when goods of the same substitutes exist.
iv. Imposition of taxes by government: Elasticity of demand helps the government in determining the imposition of taxes on goods and services.
Done studying? See all lessons in Economics
Take a quick test for this lesson!
- What do you understand by the term elasticity of demand and price elasticity of demand?
- State and explain the various types of price elasticity with the aid of diagrams.
- Solve problems relating to calculation of elasticity of demand.
- List the factors affecting the elasticity of demand.
- State the importance of elasticity of demand.
Questions answered correctly? Kudos!!
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