Introduction
When it comes to goods and services and demand of consumers for them, it is pretty obvious that the demand of goods is affected by its price. This means that whenever the price of a commodity changes, this change will affect the demand of the commodity among the consumers. This relation of the price to the demand of goods and commodities can be explained better with the help of elasticity of demand. If you have any knowledge about economic or financial terms, you will know that elasticity is a concept in economics that explains the effects of change in one economic variable on the other. Elasticity of demand, however, is a little different from the basic concept of elasticity as it specifically measures the effect of change of an economic variable on the quantity of demand of the product. The concept of elasticity of demand has its importance in the finance world and is thus important to understand. In an effort to do so, let us go through the basics of this concept and see what different types of elasticity of demand exist.
What is Elasticity of Demand?
The term “elasticity of demand” refers to the responsiveness of the quantity of demand of the product or commodity to the changes in one of the variables that are likely to affect the demand of the product. You can calculate this change in demand by simply calculating the percentage change in quantity of demand divided by the percentage of one of the variables on which the demand of the product depends.
The common variables on which the demand of the product or commodity depends are price of the commodity, prices of related commodities, consumer’s income and many more. For example, if the price of a product falls by a significant amount then the demand of the product will rise as a result of the price fall. This means that certain products see an increase in demand with decrease in the price, which shows that the said change in the price has a direct effect on the demand of the commodity.
While understanding the elasticity of demand, it is also important to understand that the effect of change in economic variables is not always on the quantity demanded for the product. The demand of the product or commodity can be both elastic as well as inelastic. While elastic demand is one where there is a larger fluctuation in demand quantity even to a small change in the economic variable, inelastic demand is when there is very little fluctuation in the quantity of demand to the change in one of the economic variables. When the demand is perfectly elastic there is a sharp rise or fall in the product’s demand due to the change in the price of a commodity. However, a relatively elastic demand is when the change in demand is greater than the change in price.
Another term that needs consideration while talking about elasticity of demand is unitary elasticity. Unitary elasticity is one where the change in quantity of demand of the product or commodity is equal to the change in one of the economic variables.
What are the types of Elasticity of Demand?
As we have already discussed, you now know that there are different variables on which the demand of the product or quality depends. Therefore, depending on the particular variable that affects the demand of the product or commodity, the elasticity of demand is classified into different types. The three main types of elasticity of demand include price elasticity, income elasticity and cross elasticity. Although all these three types are important to understand, it should also be noted that whenever the elasticity of demand is mentioned, it is considered to be price elasticity unless it has been mentioned otherwise. Now, let us have a look at all these three types separately to understand them a little better.
- Price elasticity The price elasticity of demand refers to the response of the product’s quantity of demand to the price of the product or commodity. When talking about this particular variable, it is assumed that all the other variables including the consumer’s income, tastes, and prices of all other goods are steady or constant. You can easily calculate the price elasticity of demand by dividing the percentage change in demand quantity with the percentage change in price. The formula for calculating the price elasticity of demand is as follows:
Ep = percentage change in the demand quantity / percentage change in price
In the above formula, Ep represents the symbol for price elasticity of demand.
- Income Elasticity Another variable that affects the demand of the products or commodities is the income of the consumer. Income elasticity of demand is the degree of responsiveness of the quantity of demand to the change in the consumer’s income. It should come as no surprise that an increase in the consumer’s income will cause the demand of the product to rise and the decrease in consumer’s income will cause the demand of the product and commodity to fall. The income elasticity of demand can be easily calculated by dividing the percentage change in the quantity of demand by the percentage change in the consumer’s income. The formula for calculating the income elasticity of demand is as follows:
EI = percentage change in the quantity of demand / percentage change in the consumer’s income In the above formula, the symbol EI Represents the income elasticity of demand.
- Cross Elasticity As we discussed above, the third variable that may affect the demand of the product or commodity is the change in price of other related goods and commodities. This is what cross elasticity of demand represents. Cross elasticity of demand is the responsiveness of the quantity of demand of one product or commodity to the change in price of some other related product or commodity. For example, let’s consider there are two commodities, commodity X and commodity Y. The change in demand of commodity X due to the change in price of commodity Y is what cross elasticity of demand represents.
How to Calculate it?
The elasticity is calculated by dividing the percentage that changes in quantity by the percentage price changes in a given period.
To arrive at the elasticity of demand, we have to divide the per cent change in quantity by the per cent change in price. So the elasticity of demand is the percentage change in quantity demanded as a result of a percentage change in a product’s price.
Since demand for certain products is more responsive to changes in prices, demand may be elastic or inelastic. When the demand is elastic for a product, the required quality is highly responsive to price changes. When the demand for a commodity is inelastic, the appropriate quality reacts poorly to changes in prices.
Thus, a change in price will affect the elasticity of a product’s demand. Also, it will have little effect on an inelastic product’s demand.
