What is elasticity of demand?elasticity of demand.
The degree to which demand for a good or service varies with its price. Normally, sales increase with drop in prices and decrease with rise in prices. As a general rule, appliances, cars, confectionary and other non-essentials show elasticity of demand whereas moste necessities (food, medicine, basic clothing) show inelasticity of demand.
Cross price elasticity of demand
Proportionate change in the demand for one item in response to a change in the price of another item. It is positive where the two items are mutual substitutes, and any increase in the price of one (say butter) will increase the demand for the other (say margarine). It is negetive when the items are complementary and any increase in the price of one (say cars) will decrease the demand for the other (say tires).
Demand refers to that quantity of goods or services that people are willing to buy at a given time. There a number of factors influencing this economic phenomenon. Key among these is the price of the goods or services. When a commodity is highly priced, less people will opt for it. On the other hand, a drop in price will lead to more of the same commodity being purchased. Other factors that may influence demand are the tastes and preferences of customers and the prices of substitute goods.
In this regard, elasticity of demand is a measure of how quantities of goods demanded change with slight movements in any of the factors mentioned above.
Types of elasticity of demand
i) Price elasticity of demand
This is the rate of change in quantity of goods or services demanded due to subsequent change in price. It can be expressed as a ratio or percentage by dividing the percentage change in quantity with the percentage change in price.
Demand can be said to be elastic when quantity change is more than subsequent price change. Unit elasticity is attained when change in quantity equals change in price. Price reductions increases expenditure while an increase lowers it. In unit elasticity the rise and fall in prices has no effect on expenditure. If the change in quantities demanded is lower than changes in price, this elasticity is referred to as inelastic
ii) Income elasticity of demand
Income plays an important role in how demand is influenced. When consumers experience changes in their levels of income, this will definitely have an impact in demand. Income elasticity is the extent of change in the quantity of a good demanded due to changes in a consumer’s income. Its formula is change in the demand divided by the income change.
An increase in the income of a consumer leads to an increase in demand. If the goods are normal goods, elasticity is more than zero but below one, that is, tends to one. On the other hand, inferior goods have an income elasticity of demand at anything below 1.
iii) Cross Elasticity of demand
This type of elasticity is related to substitute goods, in other words goods related to each other. For instance coffee and tea are substitutes. Cross elasticity measures the way quantity of goods demanded changes when there is a change in a substitute’s price. The formula is applied by dividing the change in price of commodity X by change in price of commodity Y.
Goods that are substitutes, like coffee and tea influence each other’s demand such that when you increase the price of coffee, demand for tea rises and vice versa.