Elasticity of Demand

What is Elasticity of Demand?
Demand extends or contracts respectively with a fall or rise in price. This quality of demand by virtue of which it changes (increases or decreases) when price changes (decreases or increases) is called Elasticity of Demand. The Elasticity of Demand is a measure of change in the quantity demanded in response to the change in the price of the commodity. Simply, the effect of a change of price on the quantity demanded is called as the elasticity of demand.

“The elasticity (or responsiveness) of demand in a market is great or small according as the amount demanded increases much or little for a given fall in price, and diminishes much or little for a given rise in price”. –Dr. Marshall.

Elasticity means sensitiveness or responsiveness of demand to the change in price.

This change, sensitiveness or responsiveness, may be small or great. Take the case of salt. Even a big fall in its price may not induce an appreciable ex appreciable extension in its demand. On the other hand, a slight fall in the price of oranges may cause a considerable extension in their demand. That is why we say that the demand in the former case is ‘inelastic’ and in the latter case it is ‘elastic’.
The demand is elastic when with a small change in price there is a great change in demand; it is inelastic or less elastic when even a big change in price induces only a slight change in demand. In the words of Dr. Marshall, “The elasticity (or responsiveness) of demand in a market is great or small according as the amount demanded increases much or little for a given fall in price, and diminishes much or little for a given rise in price.”But the demand cannot be perfectly ‘elastic’ or ‘inelastic’.

Completely elastic demand will mean that a slight fall (or rise) in the price of the commodity concerned induces an infinite extension (or contraction) in its demand. Completely inelastic demand will mean that any amount of fall (or rise) in the price of the commodity would not induce any extension (or contraction) in its demand. Both these conditions are unrealistic. That is why we say that elasticity of demand may be ‘more or less’, but it is seldom perfectly elastic or absolutely inelastic.

Marshall, a renowned economist, has suggested a mathematical method  to measure the elasticity of demand:

EP = Proportional changes in quantity demanded/Proportional changes in price

According to this formula, the elasticity of demand can be defined as a percentage change in demand as a result of the percentage change in price. Numerically, it can be written as:

Where,
ΔQ = Q1 –Q0
ΔP = P1 – P0
Q1= New quantity
Q2= Original quantity
P1 = New price
P0 = Original price

Importance of Elasticity of Demand

• The concept of demand elasticity helps in understanding the price determination by the monopolist. A monopoly is the market structure wherein there is only one seller whose main objective is to maximize the profits. The price he chooses for his product depends on the elasticity of demand. Such as, if the demand for a commodity is high he can choose the higher price as the consumers will buy the product even when the price rise. But however, if the demand is elastic, he will choose the lower prices.
• The determination of the price depends on demand for and supply of the commodity. But however, the demand is governed by the demand elasticity and the supply too is governed by the elasticity of supply. Therefore, the price of a commodity depends on both the demand and supply elasticity.
• The concept of demand elasticity also helps in understanding other types of prices, such as exchange rates, i.e. a rate at which currency unit of one country is exchanged for the currency unit of another country. Also, the terms of trade, i.e. the rate at which the exports are changed for imports can be easily understood through this concept.
• The concept of elasticity of demand also helps the government in its taxation policies. This helps the government to have a fair idea about the demand elasticity of goods which are being taxed.
• This concept also helps in the determination of wages, such as if the demand for labor is inelastic the union can demand higher wages and conversely if the labor demand is elastic the demand for higher wages could not be raised.