What is Elasticity?

Measuring the change in percentage of an economic variable with respect to change in a different economic variable is known as elasticity. This change in percentage results in a change in price concerning changes in other factors. In simple terms, when one factor brings a change to another factor, it is called elasticity. 

What is Elasticity of Demand?

When a change in quantity demanded of good changes due to change in the price of that good or the price of goods related or the consumer's income, it is called Elasticity of Demand.

Generally, the elasticity of demand can be studied in three ways:

1. Price Elasticity of Demand : It measures the change in the percentage of quantity demanded of a commodity with respect to the percentage change in the commodity's price.

2. Cross Elasticity of Demand : It measures the change in the percentage of quantity demanded of a commodity with respect to the percentage change in the price of related goods.

3. Income Elasticity of Demand : It measures the change in the percentage of quantity demanded of a commodity with respect to the percentage change in the consumer's income.

What is Price Elasticity of Demand? 

Price Elasticity of Demand (PED) is the change in the percentage of quantity demanded of a commodity with respect to the percentage change in the commodity's price.

The price elasticity of demand will show that quantity demanded and the price is inversely related. The less expensive an item is, the more likely it is to be purchased. The more expensive a thing is, the lower the demand for it.

Price elasticity of demand can be calculated using the following formula:

Price Elasticity of Demand = Rate of change of Quantity Demanded / Rate of Change in the Price

• When a minute change in the price of the commodity leads to a substantial change in the quantity demanded of the commodity, it can be said that the product is highly elastic or responsive to price changes.
  For example, in the case of high elastic products, when the price of a product, generally in a highly competitive marketplace, is slightly increased, the product's quantity demanded in the marketplace will decrease substantially. On the other hand, when the price of the same product decreases, it will result in a significant increase in the quantity demanded. This is elastic demand.
• On the opposite spectrum, we can call a product inelastic if the quantity demanded of a commodity hardly changes with a significant change in its price. In simple words, when the price of a product changes and people's demand for it is not affected considerably, it is known as inelastic demand.

Factors That Influence Price Elasticity of Demand

1. Availability of substitutes

A commodity's demand would be elastic if it already has several substitutes available in the market. If there are not substitutes for the commodity in the market, then its demand would be inelastic. For example, the elasticity of demand for a patented drug will be negligible because of a lack of competition in the marketplace. We call this Perfectly Inelastic Demand.

2. Income of the consumer 

If the income level of the consumer is very high or very low, a change in the product's price does not bring a corresponding change in quantity demanded. This leads to inelastic demand. But, when we consider average income groups, a change in the price of the commodity can result in a significant change in the quantity demanded of the commodity. Example- A high-income consumer will have a moderately low elasticity of demand.

3. The commodity's Nature

The Nature of the commodity, whether it is a luxury or a necessity, affects the elasticity of demand. The demand for necessary goods like staple food items and medicines is relatively inelastic because of how important these goods are for humans. People will willingly pay a bit extra to acquire them. Hence, when there is a variation in the price of the commodity, the quantity demanded hardly changes. Similarly, the demand for luxury goods like television and expensive cars is elastic because their use can be easily put on hold. Price elasticity of demand for goods and services with content that's a necessity for some will be almost perfectly inelastic. A decrease or increase in their prices would not reduce or raise the demand for the goods and services in the marketplace.

4. Habits

If the consumer has formed a habit of consuming a good or service, then the demand for it will stay inelastic even if there is a significant price change. For this reason, increasing the price of alcoholic beverages or tobacco products does not affect their quantity demanded or elasticity substantially. 

5. Proportion of income spent

When money spent on a commodity is a minute part of a consumer's budget, it has an inelastic demand. On the other hand, if the amount of money spent on a commodity is fairly large, it will have relatively volatile demand. For example, for products like matches, which are generally low priced, raising their price does not affect the quantity demanded and its elasticity. 

What is Elastic Marketplace?

A marketplace in which the amount of a commodity demanded is exceedingly sensitive to the price of that commodity is said to be an Elastic Marketplace. The more the sensitivity, the more elastic the marketplace is. Let's take an example if a 6 percent rise in the price of a generic medicine decreases its quantity demanded by 18 percent, the demand and price are related to each other in the ratio of 3:1. An increase in the price of the commodity reduces the quantity of the commodity demanded.

A Perfect Competition Marketplace is a great example of a perfectly Elastic Market. The products sold in these marketplaces are generally generic homogeneous goods that are easily substituted. So, even a small price change can significantly change the demand for that product.

More examples

A luxury car brand like Mercedes is part of a marketplace with high elasticity. When the price of the car increases, people can shift to brands like BMW and Volvo because these luxury cars form a substantial part of an individual's income.

Another product with high elasticity is Pepsi Cola. The soda and cola category is filled with close competitors, so if they increase the price of their drink, people may shift to close competitors like Coca-Cola.

What are Inelastic Markets?

A marketplace in which the amount of a commodity demanded is exceedingly insensitive to the price of that commodity is said to be an Inelastic Marketplace. Increase the price of the commodity does not affect the quantity of the commodity demanded.

We can see inelastic marketplaces generally in a sector where there are very few direct substitutes for the product. For example, a company selling a smart device with patented technology because the competition will not be its direct competition. It holds the patented; hence the competition cannot copy or use the same technology. This might create a monopoly.

More examples

Salt is a good example. Salt is an important part of the diet in several countries, and as of now, there is no alternative. Hence the price change does not affect the quantity demanded—the elasticity of salt is close to zero, and its slope on the graph is steep.

Context and Applications

The subject "Elastic and Inelastic Markets" is important for the professionals associated with microeconomics. The Topic is significant for students enrolled in:

• MBA
• Master in Commerce and Economics
• Bachelors in Commerce and Economics
• Bachelors in Business Administration

This Topic would help fellows planning to have research work on microeconomics, determining how a firm decides the price of the product and how the market they are part of effects the price. Concepts like "Elasticity of Demand" and "Price Elasticity" are an integral part of microeconomics.

Related Concepts

• Price Theory
• Consumer's Equilibrium
• Producer's Equilibrium
• Relationship of Demand and Supply
• Elasticity of Demand
• Elasticity of Supply

Practice Problem

Question: Does price Elasticity of demand always negative? Explain.

Solution: The Price Elasticity of demand is always negative because of the inverse relationship between a commodity's price and its demand. This means with a surge in the price of the commodity, the quantity demanded of the commodity would decrease. Similarly, due to negative elasticity, a decline in the price of the commodity would increase the quantity demanded.