The quantity of a commodity demanded per unit of time depends upon various factors such as; the price of a commodity, the money income, the tastes of the people, etc.
Whenever, there is a change in any of the factors, stated above, it brings about a change in the quantity demanded of that commodity purchased over a specified period of time.
Basically, the elasticity of demand measures the responsiveness of the quantity demanded, due to a change in any one of the above stated factors by keeping other factors constant.
Three Main Types of Elasticity of Demand:
When the demand of a product is change due to change in its price, the elasticity is said be price elasticity of demand (PED).
When the change in demand is due to change in income, it is named as income elasticity of demand.
Sometimes, a change in the price of one good causes a change in the demand for the other good, then elasticity is said to be cross elasticity of demand.
These three main types of elasticity of demand are now discussed in brief:
(1) Price Elasticity of Demand (PED):
The concept of price elasticity of demand (PED) is commonly used in economic literature. Price elasticity of demand is the degree of responsiveness of quantity demanded of a good to a change in its price. Precisely, it is defined as:
“The ratio of proportionate change in the quantity demanded of a good caused by a given proportionate change in price”.
The formula for measuring price elasticity of demand is:
Let us suppose that price of a good falls from $10 per unit to $9 per unit in a day. The decline in price causes the quantity demanded to increase from 125 units to 150 units per day. The price elasticity of demand will be:
Δq = 150 – 125 = 25
Δp = 10 – 9 = 1
Original Quantity = 125
Original Price = 10
Ed = (25/1) x (10/125) = 2
The elasticity coefficient is greater than one. Therefore the demand for the good is elastic.
The concept of price elasticity of demand can be used to divide the goods into three groups.
(i) Elastic. When the percentage in quantity of a good is greater than the percent change in its price, the demand is said to be elastic. When elasticity of demand is greater than one, a fall in price increases the total revenue (expenditure) and a rise in price lowers the total revenue (expenditure).
(ii) Unitary Elasticity. When the percentage change in the quantity of a good demanded equals to percentage in its price, the price elasticity of demand is said to have unitary elasticity. When elasticity of demand is equal to one or unitary, a rise or fall in price leaves total revenue unchanged.
(iii) Inelastic. When the percentage in quantity demanded is less than the percentage change in its price, the demand is called inelastic. When elasticity of demand is inelastic or less than one, a fall in price decreases the total revenue and a rise in its price increases the total revenue.
(2) Income Elasticity of Demand:
Income is an important variable affecting the demand for a good. When there is a change in the level of income of a consumer, there is a change in the quantity demanded of a good, other factors remaining the same. The degree of change or responsiveness of quantity demanded of a good to a change in the income of a consumer is called income elasticity of demand. Income elasticity of demand can be defined as:
“The ratio of percentage change in the quantity of a good purchased, per unit of time to a percentage change in the income of a consumer”.
The formula for measuring the income elasticity of demand is the percentage change in demand for a good divided by the percentage change in income.
A simple example will show how income elasticity of demand can be calculated. Let us assume that the income of a person is $4000 per month and he purchases six CD’s per month. Let us assume that the monthly income of the consumer increase to $6000 and the quantity demanded of CD’s per month rises to eight. The elasticity of demand for CD’s will be calculated as under:
Δq = 8 – 6 = 2
Δp = $6000 – $4000 = $2000
Original quantity demanded = 6
Original income = $4000
Ey = (Δq/Δp) x (P/Q)
Ey = (2/200) x (4000/6) = 0.66
The income elasticity of demand is 0.66 which is less than one.
When the income of a person increases, his demand for goods also changes depending upon whether the good is a normal good or an inferior good. For normal goods, the value of elasticity is greater than zero but less than one. Goods with an income elasticity of less than 1 are called inferior goods. For example, people buy more food as their income rises, but the % increase in its demand is less than the % increase in income.
(3) Cross Elasticity of Demand:
The concept of cross elasticity of demand is used for measuring the responsiveness of quantity demanded of a good to changes in the price of related goods. Cross elasticity of demand is defined as:
“The percentage change in the demand of one good as a result of the percentage change in the price of another good”.
The formula for measuring, cross, elasticity of demand is:
The numerical value of cross elasticity depends on whether the two goods in question are substitutes, complements or unrelated.
Types and Example:
(i) Substitute Goods. When two goods are substitute of each other, such as coke and Pepsi, an increase in the price of one good will lead to an increase in demand for the other good. The numerical value of goods is positive.
For example there are two goods. Coke and Pepsi which are close substitutes. If there is increase in the price of Pepsi called good Y by 10% and it increases the demand for Coke called good X by 5%, the cross elasticity of demand would be:
Exy = (%Δqx/%Δpy) = 0.2
Since, Exy is positive (E > 0), therefore, Coke and Pepsi are close substitutes.
(ii) Complementary Goods. However, in case of complementary goods such as car and petrol, cricket bat and ball, a rise in the price of one good say cricket bat by 7% will bring a fall in the demand for the balls (say by 6%). The cross elasticity of demand which are complementary to each other is, therefore, (6%/7%) = 0.85 (negative).
(iii) Unrelated Goods. The two goods which are unrelated to each other, say apples and pens, if the price of apple rises in the market, it is unlikely to result in a change in quantity demanded of pens. The elasticity is zero of unrelated goods.