Explain the concept price elasticity of demand and distinguish between elastic and inelastic demand. Give examples.
Price elasticity of demand is a measure of the extent of impact of change in price of a good on the quantity of that good demanded. When the price of a goods is increases there is a tendency for the demand of to decrease. Conversely, when the price of a product is decreases there is a tendency for the demand of the product to increase. However, the extent to which the price impacts the demand differs widely from produce to product.
The relationship between price and demand of a product, called price elasticity of demand, or simply elasticity of demand is defined by the following equation.
Elasticity of demand = (Percentage change in demand)/(Percentage change in price)
Since rise in price leads to reduction in price and vice versa, the elasticity of demand as given by the above equation works out to be a negative number. However in practice the only the magnitude of the number is considered therefore elasticity is taken as a positive number.
When the elasticity of a product is more than 1, the product is said to have elastic demand. When the elasticity of a product is less than 1, the product is said to have inelastic demand.The product with elasticity equal to one is said to have unit elastic demand.
Products that do not fulfill essential needs, whose consumption or purchase can be delayed, have substitute products available, and form large part of total spending of consumers tend to have elastic demand. For example, people may defer their holiday plans and decide to spend their holidays in alternate ways, when there is rise in travel fares and other cost. Therefore, demand for holiday destination is likely to be have elastic demand.
In contrast, Products that do fulfill essential needs, whose consumption or purchase can not be delayed, don't have substitute products available, and form small part of total spending of consumers tend to have inelastic demand. For example it is quite unlikely that there will be significant drop in demand for common salt if the prices are increased.