Elasticity of Demand is the measurement of the
responsiveness of change in demand for the product due to change in price of
the product or income of the consumer or price of the substitute product.
Therefore Elasticity of Demand is important contribution in Demand Analysis
with the help of which the change in consumer behavior can be identified.
Elasticity of Demand is of the following types:
(1) Price Elasticity of Demand
(2) Income Elasticity of Demand
(3) Cross Elasticity of Demand
(4) point Elasticity of Demand
(5) Arc Elasticity of Demand
(1) Price Elasticity of Demand
It is derived from price effect of law of demand. In the
price effect of law of demand we observe that demand for the product and price
of the product both are inversely related and therefore sign of price
elasticity of demand is negative.
It can be calculated with the haelp of following
formula,
PED = (Proportionate change in demand) /
(Proportionate change in price)
or,
PED = [(change in demand)/(original demand)] / [(change
in price)/(original price)]
or,
PED = [(change in demand)/(original demand)] X [(original
price)/(change in price)]
or,
PED = [(change in demand)/(change in price)] X [(original
price)/(original demand)]
With the help of above formula we get different types
of result and each result represent one specific type of elasticity of demand. The
results are as –
Result > 1
It is elastic demand. In this situation we get that
rate of change of demand is always is always more than rate of change in price.
Result < 1
It is inelastic demand. In this situation we get that
rate of change of demand is always is always less than rate of change in price.
Result = 1
It is Unit Elastic Demand. In this situation we
observe that rate of change in demand and rate of change in price both are
identical.
Result = 0
It is Perfectly Inelastic Demand. In this situation we
observe that rate of change in demand is zero whatever may be the rate of
change in price.
Result = infinity
It is Perfectly Elastic Demand. In this situation we
observe that there may be a very significant change in demand parameter due to
a very small change in price parameter and even sometime there is at all no
change in price parameter.
(2) Income Elasticity of Demand
It is the measurement of the responsiveness of change
in demand parameter due to change in real income parameter. This elasticity
of demand is realized from income effect of law of demand where we
observe that Demand and Real income parameter both are positively related and
hence its sign is always positive.
Income ealaticity of demand can be calculated with the
help of following formula -
IED = (Proportionate change in demand) /
(Proportionate change in income)
or,
IED = [(change in demand)/(original demand)] / [(change
in income)/(original income)]
or,
IED = [(change in demand)/(original demand)] X [(original
income)/(change in income)]
or,
IED = [(change in demand)/(change in income)] X [(original
income)/(original demand)]
We get different types of result and each result
represent one specific type of income elasticity of demand. The results are as –
Result > 1
It is Elastic Demand. Rate of change of demand is
always more than the rate of change in income.
Result < 1
It is Inealstic Demand. Rate of change of demand is
always less than the rate of change in income.
Result = 1
It is Unit Elastic Demand. In this situation we
observe that rate of change in demand and rate of change in income both are
identical.
Result = 0
It is Perfectly Inelastic Demand. In this situation we
observe that rate of change in demand is zero whatever may be the rate of
change in income.
Result = infinity
It is Perfectly Elastic Demand. In this situation we
observe that there may be a very significant change in demand parameter due to
a very small change in income parameter and even sometime there is at all no
change in income parameter.
(3) Cross Elasticity of Demand
Cross elasticity of demand is derived from
substitution effect of law of demand. In
this situation demand for a product is directly dependent on the price of its
substitute product. As demand for the product and price of its substitute
product are positively related the sign of Cross elasticity of demand is
positive.
If X and Y are two substitute products in the market
then
Cross EOD of product X = (proportionate change in
Demand for X) / (proportionate change in Price of Y)
and,
Cross EOD of product Y = (proportionate change in
Demand for Y) / (proportionate change in Price of X)
(4) Point Elasticity of Demand
In this case the manager is interested to measure the elasticity
of demand at a particular point of the demand curve. In this situation a
particular point is identified where a tangent is drawn. Point
elasticity of demand is equal to lower segment of tangent divided by upper
segment of tangent.
PED = (lower segment of tangent) / (upper segment of
tangent)
(5) Arc Elasticity of Demand
In this case the manger is interested to measure the
elasticity of demand at a particular range of the demand curve.. a particular
range is identified where elasticity of demand is being measured.
AED = (proportionate change in demand at the particular
range of demand curve) / (proportionate change in price at that particular
range)
Thus we observed that with the help of elasticity of demand
we can identify the consumer behavior. The manager can understand the nature of
change in consumer psychology due to change in independent variable, i.e.,
price of the product, income of the consumer and price of the substitute
product.