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To find out the magnitude of impact on the quantity of demand for economists use the tool of elasticity of demand.
Definition:
Elasticity of demand is defined as " the percentage of change in quantity demanded caused by one percent change in the demand determinant under consideration while other determinant are held constant. This can be replaced as
e= percentage change in quantity of demanded of goods(q)/ percentage change in demand determinant (z).
The above definition can be simplified into " the degree of responsiveness of quantity demanded to a change in the demand determinant".
The formula is
e = proportionate change in the quantity demanded/ proportionate change in price.
Elasticity of demand means " the rate at which demand may change when price changes is known as elasticity of demand".
Types of Elasticity of demand:
1. PRICE ELASTICITY OF DEMAND:
Price elasticity of demand refers to elasticity of demand for a good with respect to it's own price. It can be defined as " the degree responsiveness of quantity demanded to a change in price".
Price elasticity of demand,
ep= proportionate change in the quantity demanded/ proportionate change in price
ep= ( (Q2-Q1)/Q1) / (( P2-P1)/P1)
Q1= Original quantity demanded before the price change
Q2= New quantity demanded after the price change
P1= Original price ( before change)
P2= New Price ( after change)
Types of price elasticity:
Different products react differently to the price change. Price elasticities are classified into the following categories
1. Perfectly elastic demand
There is no need for reduce in price to cause an increase in demand.
2. Absolutely or perfectly inelastic demand
Absolutely inelastic demand is where a change in price cause no change in the quantity demanded for a product. Eg: rice, wheat
3. Unit elasticity of demand
Unit elasticity is where a given proportionate change in price causes an equal proportionate change in the quantity demanded of the product.
4. Relatively elastic demand
Reduction in price leads to more than proportionate change in demand.
5. Relatively inelastic demand
Decline in price leads to less than proportionate increase in demand.
Factors determining price of elasticity of demand:
1. Nature of product: Demand for necessity goods ( rice, sugar) are inelastic. The demand for luxury goods are elastic.
2. Extend of usage: Product has varied usaged( steel, wood etc.) are elastic demand.
3. Availability of substitutes: If a product many substitute then demand will be elastic. Product has no substitute has inelastic demand.
4. Income level of people: People with high income are less affected by price level changes people with low income will affected by price changes.
5. Proportion of income spent on the community: When a person spends only a very small part of his income then the demand is inelastic.
6. Urgency of commodity: If a person requires buying a product immediately no matter or no way to have substitute the demand for that product is inelastic. Eg: building construction
7. Durability of a commodity: If a product have high life then the demand is elastic.
2. INCOME ELASTICITY OF DEMAND:
Income elasticity of demand may be defined as the degree of responsiveness of quantities demanded to a change in income. It can be measured by the following.
ei = proportion change in quantities demanded / proportionate change in income.
ei =( (Q2-Q1)/(Q2+Q1)) /( (I2-I1)/(I2+I1))
Q1 = Q1 is the quantity demanded before the change in income.
Q2= Q2 is the quantity demanded after the change in income.
I1 = Income before the change
I2 = Income after the change
Types of income elasticity:
It includes
1. High income elasticity
2. Unitary income elasticity
3. Low income elasticity
4. Zero income elasticity
5. Negative income elasticity
6. Positive income elasticity
1. High income elasticity:
The quantity demanded for a product increases by a larger percentage than the percentage increase in the customer or vice versa. The value of income elasticity is greater than one.
2. Unitary income elasticity:( ei=1)
Percentage change in the quantity demanded by a customer in equal to the percentage change in income.
3. Low income elasticity ( ei<1)
Income elasticity is low if the relative change in quantity demanded is less than the relative change in income.
4. Zero income elasticity(ei=0)
The change in income will have no effect on the quantities demanded.
5. Negative income elasticity
An increase income may lead to a reduction in the quantities demanded for certain Products.
6. Positive income elasticity
An increase in income may lead to increase in the quantities demand for most goods the income elasticity of demand is positive.
3.CROSS ELASTICITY OF DEMAND:
The effect of change in price of related Products depend upon the demand for a particular product may be determined by measuring the cross elasticity of demand. Cross elasticity of demand may be defined as the proportionate change in the quantity demanded of a particular product or commodity in response to a change in the price of another related product.
4. ADVERTISING ELASTICITY OF DEMAND OR PROMOTION ELASTICITY:
The formula to measure this elasticity is
ea= proportionate change in demand / proportionate change in advertising expenditure.
ea= ((Q2-Q1)/(Q2+Q1)) / ((A2-A1)/(A2+A1)).
Q1- demand before advertising
Q2- demand after advertising
A1- Original advertising activity
A2- New advertising activity
Factor determing advertising elasticity of demand are the type of products. The market share of the firm competitors relation and the state of the economy.
5. EXPECTATION ELASTICITY OF DEMAND:
As per this type of demand for a product is affected not only by the current price but also by the expected future price. If a consumer feels that the price of a product is going to rise in the future he will try to buy more of it's now. Thus the expectation of a price rise about the future increases the demand at present.
ee= relative change in expected future price/ relative change in current price
ee= ((pe2-pe1)/(pe2+pe1)) / ((pc2-pc1)/(pc2+pc1))
Where pe1&pe2 are expected price
pc1&pc2 are the current price.