Elasticity of Demand
- Concept / Term
- Elasticity of Demand
- Branch
- Microeconomics
- Definition & Explanation
Elasticity of Demand
Elasticity of Demand measures the responsiveness of the quantity demanded of a good or service to a change in one of its determinants (price, income, or price of related goods).
Price Elasticity of Demand (PED)
Price Elasticity of Demand (PED) specifically measures how much the quantity demanded responds to a change in the price of the good itself.
$$ \text{PED} = \frac{% \text{ change in quantity demanded}}{% \text{ change in price}} $$
Types of Price Elasticity
Type PED Value Description Example Perfectly Inelastic $0$ Quantity demanded does not change at all with price. Life-saving medication Inelastic $0 < \text{PED} < 1$ Quantity demanded changes proportionally less than price. Salt, basic utilities Unitary Elastic $1$ Quantity demanded changes proportionally to price. Some manufactured goods Elastic $\text{PED} > 1$ Quantity demanded changes proportionally more than price. Luxury items, foreign travel Perfectly Elastic $\infty$ Consumers will buy all they can at one price, but none at a higher price. Products with many perfect substitutes Determinants of Price Elasticity
Several factors influence how elastic or inelastic the demand for a good is:
- Availability of Substitutes: The more close substitutes a good has, the more elastic its demand tends to be, as consumers can easily switch if the price changes.
- Necessity vs. Luxury: Necessities (e.g., basic food, shelter) tend to have inelastic demand, while luxuries (e.g., designer clothes, high-end electronics) tend to have elastic demand.
- Proportion of Income Spent: Goods that represent a large portion of a consumer's income tend to have more elastic demand because a price change has a greater impact on their budget.
- Time Horizon: Demand is generally more elastic in the long run than in the short run, as consumers have more time to find substitutes or adjust their consumption patterns.
Income Elasticity of Demand (YED)
Income Elasticity of Demand (YED) measures the responsiveness of quantity demanded to a change in consumer income.
- Positive YED: Indicates a normal good (demand increases with income).
- Negative YED: Indicates an inferior good (demand decreases with income).
- YED greater than 1: Typically signifies a luxury good (demand increases significantly with income).
Cross Elasticity of Demand (XED)
Cross Elasticity of Demand (XED) measures the responsiveness of the quantity demanded of one good to a change in the price of another good.
- Positive XED: Indicates that the two goods are substitutes (e.g., if the price of coffee rises, demand for tea increases).
- Negative XED: Indicates that the two goods are complements (e.g., if the price of cars rises, demand for petrol decreases).