Elasticity can be described
as Response to Change.
Elasticity of demand is the response in demand to a change in avariable. For example, the following forms of elasticity of demand are price elasticity of demand (PED), income elasticity of demand (YED) and cross elasticity of demand (CED) which are defined as follows
PED: The response in demand
to a change in price
YED: The response in demand to a change in income
CED: The response in demand for one good to a change in the demand for another
If the price of a brand of washing powder increases the demand will fall. Elasticity of demand measures the degree by which consumers reduce their demand for that particular product.
2 Elasticity Scale
Goods are either unitary,
elastic or inelastic as demonstrated on the Elasticity Scale above. It
should be stated that the figures are absolute since –4 is greater than
–2 and –12 is greater than –4.
There is a theoretical form of elasticity which measures elasticity as + 1 or – 1. This is known as unitary elasticty. If the price rises 10% and demand falls 10% giving an elasticity measure of -1.
Elastic goods are those which respond strongly to a change in price or a change in income. The further out the Scale the greater the response. For example Good A which measures –10 is more elastic than Good B which measures –2. Elastic goods tend to be in the "luxury" category such as satellite television stations, mobile phones or luxury holidays.
Inelastic goods are those which if there was a change in price there would be only a slight change in demand. Examples of such goods would be milk, bread, cigaarettes, beer or petrol.
The sign in front of the value will put the good into a category. If the good has a Price Elasticity of Demand of –2.4 this means that it is Normal and Elastic. It is Elastic because it is greater that –1. It is Normal because it has a negative value. This arises when the two variables, price and quantity demanded, move in opposite directions. When the price rises (+) demand falls (-) and as in mathematics subscribes to the tenet that "Unlike Signs give Minus"
5 Price Elasticity of Demand
Price elasticity of demand refers to a situation where an increase in price will lead to a fall in demand for a normal good such as clothes, bus fares and cars. Should a fall in price result in a fall in demand such goods are categorised as perverse. If the price of a perverse good increases demand also increases. Examples of such goods are Giffen goods, snob goods, ostentatious goods and expectations. If an investor sees shares increase in price and expects that the price of shares will continue to increase he will increase his demand.
6 Income Elasticity of Demand
This is the response in demand to a change in income. It refers to normal goods and inferior goods. A normal good will have a positive value. As consumers’ incomes increase (+) more normal goods will be bought (+) [Like Signs Give Plus]. However, if their incomes increase (+) and they buy less (-) then these are classified as Inferior goods such as remould tyres.
7 Cross Elasticity of Demand
If the price of one good
changes it can have an impact on the demand for other goods. These goods
are closely related and are known as Substitutes and Complements. Substitute
If the price of Nescafe coffee increases many consumers will stop buying Nescafe annnd switch to an alternative. There will be an increase in demand for Maxwell House one of its substitutes. Substitute goods have a positive value because the price of Nescafe increases (+) the demand for Maxwell House also increases (+).
Complementary goods are goods that go with each other. They have a negative value. An example would be cars and petrol. If the price of cars increase (+) demand for petrol will fall (-).
8 Factors affecting Elasticity of Demand
Below are those factors which determine the price elasticity of demand
If the product is durable or long lasting, such as a car, an increase in its price may cause the consumer to postpone replacement of the existing model. The more durable the the the more likel;y it is to be price elastic.
Where loyalty to a product is a factor in the consumer’s demand the demand will be price inelastic. They will continue to buy even if there is an increase in price.
If two goods are in Joint Demand, such as cars and petrol, (also known as Complementary Demand), the demand for the cheaper is likely to price elastic.
In general, the greater the number of clsoe substitutes available for a product, the more likely demand for that product will be responsive to changes in its price, they are elastic. Goods with few close substitues will be price inelastic.