Elasticity of Demand: Types and Applications

Demand that is relatively elastic suggests that a change in the price of a good or service will have an effect on the quantity required of that good or service. A product or service is typically said to have significant price elasticity when there are several replacements available.

Example: You might see salt and a variety of salt alternatives when you browse the aisle at the grocery store. Would you be willing to pay an extra 2 for a bag of salt if there were salt replacements instead if the price of salt increased by 2 per bag tomorrow? Most people would switch from preferring salt to one that contains sugar substitutes, which would lower their demand for pure salt. Since most economists concur, salt is viewed as a good with a high degree of elasticity. 

Relatively Elastic demand

Relatively Elastic demand

Types of Elasticity of Demand

Elasticity of demand is classified into three types based on the many elements that influence the quantity desired for a product:

1. Price Elasticity of Demand (PED), 

2. Income Elasticity of Demand (IED) (YED), and

3. Cross Elasticity of Demand (XED)

1)Price Elasticity of Demand (PED)

The Price Elasticity of Demand (PED) is the quantity requested for a product is affected by any change in the price of a commodity, whether it be a drop or an increase. For example, as the price of ceiling fans rises, the quantity requested decreases.

The Price Elasticity of Demand is a measure of the responsiveness of quantity sought when prices vary (PED).

The mathematical formula for calculating Price Elasticity of Demand is as follows:

• PED = %Change in Quantity Demanded % / Change in Price.

• The formula's output determines the magnitude of the influence of a price adjustment on the amount required for a commodity.

2). Income Elasticity of Demand (YED)

The Income Elasticity of Demand (YED) is the Consumer income levels have a significant impact on the amount requested for a product. This may be seen in the contrast between commodities sold in rural marketplaces and those sold in urban markets.

The Income Elasticity of Demand, commonly known as YED, refers to the sensitivity of the quantity requested for a certain commodity to changes in real income (the income generated by a person after accounting for inflation) of the consumers who buy this good, while all other variables remain constant.

The formula for calculating the Income Elasticity of Demand is as follows:

• YED = % Change in Quantity Demanded% / Change in Income

The formula's output may be used to assess if a product is a need or a luxury item.

3. Cross Elasticity of Demand (XED)

In the Cross Elasticity of Demand (XED), in an oligopolistic market, numerous companies compete. Thus, the amount desired for a commodity is affected not only by its own price, but also by the prices of other items.

Cross Elasticity of Demand (XED) is an economic term that assesses the sensitivity of quantity requested of one good (X) when the price of another item (Y) changes, and is also known as Cross-Price Elasticity of Demand.

The formula for calculating the Cross Elasticity of Demand is as follows:

• XED = (% Change in Quantity Demanded for one good (X)%) / (Change in Price of another Good (Y))

The result for a substitute good would always be positive since anytime the price of an item rises, so does the demand for its alternative. In the case of a complementary good, however, the outcome will be negative.

What Makes a Product Elastic?

A product is considered elastic when even a small change in its price causes a significant change in how much people buy. This often happens when there are plenty of substitutes available, meaning buyers can easily switch to a similar product if the price rises. Products that are not essential or are considered luxury items tend to be more elastic because people can reduce or delay their purchases when prices increase. Additionally, if a product takes up a large portion of a person’s budget, they are more likely to react to price changes, making it more elastic.

Factors Affecting Elasticity of Demand

• The more substitutes available, the easier it is for people to switch, making demand more elastic.

• Necessities are inelastic because people need them, while luxuries are elastic as they can be skipped.

• Expensive items that take up a large part of income are more elastic, while cheaper items are inelastic.

• Demand is more elastic in the long run because people have time to find alternatives or adjust.

• Products that are addictive, like cigarettes or coffee, have inelastic demand as people keep buying them despite price changes.

Importance of Elasticity of Demand

• Businesses use elasticity to decide pricing strategies. If demand is inelastic, they can raise prices to boost revenue without losing many customers.

• Governments focus on taxing inelastic goods (like fuel or tobacco) because people continue buying them even with higher taxes.

• Elasticity helps businesses understand if lowering prices will attract more buyers and increase overall revenue.

• Policymakers use elasticity to predict how price changes (e.g., in essential goods) will affect consumer spending and the economy.

• Countries prioritize exporting goods with inelastic demand to ensure stable trade revenues even during price fluctuations.

Relatively Elastic Demand Example

The majority of necessities tend to be very inelastic.

Example : A youtube business with 50,000 subscribers offers a service for 100 a year. The corporation increases the subscription service's cost by 30%, from 100 per year to $130. The company now has 52,000 users, a 4 % increase after the price rise. The service is comparatively inelastic because the price increased by 30% while the demand increased by only 4%.

Conclusion

Economists attempt to quantify the degree to which demand is sensitive to changes in price for a particular good using the concept of price elasticity of demand. This assessment can be helpful in predicting consumer behaviour as well as big occurrences like an economic recession or recovery. Every day, as customers, we make choices that economists track. We may consume less of a good or none at all if its price rises and we can survive without it, there are many replacements, or both. Despite price hikes, we will continue to demand large amounts of water, medicine, and gasoline as needed.