Elasticity of demand is the degree of change in demand or the responsiveness of quantity demanded to change in the price of the product. In other words it’s the percentage change in demand due to some percentage change in price of the same product. The price elasticity of demand is always negative.
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Price Elasticity of Demand= % change in quantity demanded/ % change in price
Cross Price Elasticity
Measuring the responsiveness of demand of the related product (complementary or substitute) due to change in the price of the related product (complementary or substitute) defines cross price elasticity. In the case of substitutes, the cross elasticity of demand is positive, but negative in the case of complementary goods.
Cross-Price Elasticity of Demand= % change in quantity demanded of one good/%
Income elasticity of demand
Income elasticity of demand is related with the change in income and its effect on the change in demand, that is income elasticity of demand measures the degree of change or the responsiveness of change in demand due to change in the income of the consumer. Income elasticity of demand is positive in the case of normal products and negative in the case of inferior products.
Income Elasticity of Demand= % change in quantity demanded/% change in Income
Elasticity coefficient for price elasticity of demand takes a negative value. With normal goods, the elasticity coefficient for the income elasticity of demand will be positive. When inferior goods are involved the elasticity coefficient for the income elasticity of demand is assumed to be negative. The coefficient of cross price elasticity of demand for complement goods will be negative and for substitutes the coefficient will be positive. Price elasticity involves the price of the product being studied. However, cross price elasticity of demand measures the changes in the degrees of demand, when the price of related product changes. The income elasticity of demand doesn’t measure the changes due to price but the changes due to a consumer’s change in income.
All the three terms are vital to business firms’ ability to assess the demand of their products in the market. The difference in measuring these types of elasticity is also very important, because entrepreneurs and managers do not require only the relationship between demand and price but also the effects on demand of their products due to changes in other determinants like income and the price of related goods. The price elasticity of demand tells us how much there will be movement along the demand curve, but the income and cross price elasticity tells us the degree of shift in the demand curve (leftwards or rightwards) of the product in question. With the scarcity of the substitutes the demand would be less elastic and vice versa. If the larger portion of the consumer income is gone in purchasing a given product, then demand would be more elastic like the purchasing of a boat, for example. On the other hand if the smaller portion of the income goes in the purchase of the product like music compact discs, the demand would be less elastic. Given the consumer has more time and is not pressured to purchase a good, the demand for that good would be elastic. And, if the consumer has a little time to choose between the goods, then his demand would be less elastic.
The first example is restaurant’s cuisine. When there are many restaurants available in the locality the demand for the food of a specific restaurant would be elastic. But, if only once restaurant is in a locality the demand for food would be less elastic. With the assumption that other things are the same, the restaurant owner has to be very competitive by setting a lower price on the menu’s cuisine, possibly starting with the competition’s most popular items. This is if there are many restaurants available in that locality, otherwise when no substitute is available it can charge monopoly price.
The second example is a car which consumes a great deal of consumer income, and the demand would be elastic. Household cleaning supplies takes a small amount from consumers’ income and the demand is less elastic. With the assumption other things being same, the producers of household cleaning supplies can increase the price of such products a little without losing revenue. Whereas, the owner of the car company has to be very calculative in changing the price of the car, since this may make large changes in the revenue collection.
The third example is if we are attempting to purchase an airline ticket for an emergency flight to comfort bereaving loved ones. We will not mind if the airfare charge is higher than normal, because the demand became inelastic. On the other hand in a holiday, going to friend’s home, we will mind paying any extra amount to taxi since we are not in hurry and we will wait for the other taxi to come, the demand becomes elastic. With the assumption other things being same, business decision especially of price setting requires lot of knowledge of the elasticity of demand and its determinant. We can see in our example that airfare charges are more costly when the consumer has not time, in the same way fares are at a normal set price if he wants to sell his services since when there is enough time for the consumer to choose among the goods and services.
Perfectly inelastic demand and perfectly elastic demand are the two extremes between which other ranges of elasticity exist. Generally in real world the examples of these two concepts are not available. In the case of perfectly inelastic demand, the demand curve is vertical. There is no change in demand, whatever may be the change in price (decrease or increase), and the elasticity is zero.
With the perfectly elastic demand, the demand curve is horizontal and the demand changes with even a negligible or no change in the price, the elastic in this case is infinity.
The graphs below show the perfectly elastic demand curve and perfectly inelastic demand curve.
When demand is perfectly elastic demand curve is horizontal and when demand is perfectly inelastic, the curve is vertical.
Elastic range : The elastic range occurs as the price moves from $40 to $80 and the quantity demanded decreases from 5 units to 1 unit, this result in the decrease in total revenue from $200 to $$80.
Inelastic range: The inelastic range occurs as the price increases from $10 to $40 and the quantity demanded decreases from 8 units to 5 units. The total revenue increases from $80 at price $200 at this range.
Unit-elastic range: The unit elastic is a point where the price is $40 and the demand is 5 units, at this price the total revenue is maximized at $200, if from this point we increase or decrease the price the total revenue will decrease. The demand is inelastic below this point and elastic above this point.