Elasticity of Demand

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It is important in economics to see the changes in one variable due to changes taking place in other variables. Such comparisons are central to the ideas of economic changes. The elasticity of demand is such a concept that relates the changes in one variable to the changes taking place in other variables.

What is Elasticity of Demand?

In general, elasticity means the sensitivity of a variable to changes in other variables. In the case of price elasticity of demand, the changes in demand are checked against the changes in the price of a product. In economics, price elasticity is used to indicate the degree to which consumers or producers change the demand or the supply of products against the changes in price or income. It is mainly used to check the consumer demand for a product when its price of it changes in the market.

Usually, the demand for a product in the market changes with increasing and decreasing prices. In general, when the price of a commodity is reduced, its demand goes up. On the other hand, when prices go down, the demand for the product usually goes up.

This change in prices and its effects on demand is known as price elasticity of demand. However, when the price is substituted by income or advertising expenditures, the elasticity in demand is called income elasticity or advertising elasticity of demand respectively.

Therefore, we may state that elasticity in demand is the increase or decrease in demand or the amount supplied when the underlying factors, such as price or income change. These changes are often common in economics. Therefore, the idea of elasticity in demand is of great importance in economics.

Generally,

$\mathrm{Price\: Elasticity\: of\: Demand = \frac{Proportionate\: Change\: In\: Demand\: Of\: Quantities}{Proportionate\: Change \:In\: Price}}$

Factors Determining Price Elasticity of Demand for Goods

The price elasticity of demand depends upon the following four factors −

  • availability of close substitutes −If there is a close substitute for an item available in the market, then consumers can choose available options when the price of a commodity changes. In other words, when close substitutes are available, and the price of a commodity changes, the consumers may shift to a less pricey product. This will affect the demand for the product. Usually, the availability of close substitutes plays a major role when there is an increase in the prices of a commodity. With increasing prices, consumers may opt for the substitute of the product. This affects demand negatively or the demand for the product in the market goes down. Therefore, when close substitutes are present, the elasticity of demand is considered elastic. When there is no close substitute, the price elasticity would be considered inelastic.
  • Whether the good is a necessity or a luxury − The elasticity of demand also depends on the type of commodity. If it is a necessity, people won’t change their preferences even if prices change. So, it will be inelastic.
  • Example of such goods − includes insulin which cannot be replaced by any other drug and must be taken by people with diabetes. On the other hand, if it is a luxury, people may choose to buy or not buy the item. So, there will be elasticity attached to luxury goods or items.
  • The proportion of income spent − The elasticity of a product is also dependent upon income and the price of the product. When the price of the product is a small fraction of the income, the demand will be less elastic. However, when the price of the item is large in proportion to the income, the consumer will buy the item more when the price of the item goes down. Similarly, when the price of the item that requires enough money goes up, the propensity to buy it will come down. So, when the prices of products require higher amounts of income, the demand is said to be more elastic.
  • Time elapsed after a change in price − Time elapsed in a change in price is also an important factor in the determination of price elasticity of demand. As time passes, the consumers can find more options to buy products that are available in the market. So, when more time elapses after a change in price, the elasticity of demand for the product goes up.

Expenditure Elasticity of Demand

Expenditure elasticity is a measure of the responsiveness of demand to changes in expenditure. It generally shows the change in demand due to a change in consumer expenditure. The expenditure is recorded for a bundle of similar products that can be separated and secluded from similar goods.

In some cases, such as in the case of Almost Ideal Demand Systems (AIDS), the expenditure used is that of budget share and not of households. In general, expenditure elasticity of demand is calculated by dividing the percentage change in quantity demanded by the percentage change in consumer expenditure.

When the percentage change in quantity demanded is more than the percentage change in expenditure, the demand is termed to be expenditure elastic. In the case the expenditure percentage is more than the percentage change in demand, the demand is said to be expenditure inelastic.

The AIDS demand system is more commonly used to determine expenditure elasticity of demand. On the other hand, modeling demand in terms of commodity groups according to budget shares and expenditures is concerned with the composite commodity theorem, the theory of reparability of commodities, and the process of two-stage budgeting.

Conclusion

In addition to the two types of elasticity of demand mentioned above, there are a few more concepts of elasticity, such as income elasticity of demand, cross elasticity, and advertising elasticity of demand. It must be noted that the main idea of the calculation of all types of elasticities of demand is to determine the changes in demand due to changes in other variables.

The concept of demand is a very important idea in economics because all of the other concepts are usually connected to the concept of demand in one way or the other. The elasticity of demand shows the extent to which the demand can change and therefore it is an indication of the requirements of the consumers or the required supply from the end of producers.

Producers and sellers should have knowledge of the price elasticity of demand because without knowing this parameter, having an idea of changes in demand due to changes in the price of commodities cannot be established. As price is sensitive and is the determining factor for consumer choice, the price elasticity of demand will remain a concept of major importance for economists forever.

FAQs

Q1. What is the most notable factor influencing the price elasticity of demand?

Ans. The availability of close substitutes is the most notable factor influencing the price elasticity of demand. As consumers have the option of substitutes, they can shift to them when there is a change in the prices of commodities. Therefore, demand will be more elastic when the availability of products is more available.

Q2. Does elasticity of demand affect supplies?

Ans. Yes. The elasticity of demand affects supply directly. When demand is high, the supply must also go up and vice versa.

Q3. What is the full form of AIDS which is a common concept in economics?

Ans. AIDS stands for Almost Ideal Demand Systems.

raja
Updated on 13-Oct-2022 11:19:47

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