What is the Elasticity of Demand?  | An Overview

The concept of elasticity of demand plays a crucial role in the pricing decisions of the business firms. It is also essential in judging the effect of the devaluation of a country’s currency. Whenever the finance minister considers tax imposing on various commodities, he has to check the elasticity of demand. To fix the prices of different goods to be exported, it is essential to know the prices.

Change in the prices of a product brings a difference in the quantity demand. Therefore, business firms have to keep checking the elasticity of demand while making decisions about the pricing of goods and services. It is also crucial in the field of international trade. If the market for a country’s export is elastic, then the fall in the prices of goods will bring a high demand in quantity.

The Elasticity of Demand Definition

The elasticity of demand commonly refers to the price elasticity of demand because it is the most common factor in measuring the price of elasticity. It is about how demand for a good compared to changes in other economic factors like income or rates. In the graph of elasticity of demand, it has a negative slope.

A good or service with elastic demand means consumers will do a lot of shopping comparatively. Thus the law of demand deals with the relationship between price and the quantity bought. According to it, the quantity purchased is in inverse relation with the price. Therefore if the price rises, consumers will buy less. And the elasticity of demand measures how much the quantity bought decreases when the price increases.

Price elasticity of demand measured in absolute terms. If the price of elastic demand is greater than one, then it is elastic. However, if it is less than one, then the price elasticity of demand is inelastic. It is “unit elastic” when it equals to one. For example, if the price of candy increases by 2%, then 2% of its consumers will switch to another brand of candy.

Elastic Curve Demand

The easiest way to determine the elasticity of demand is to look at the curve. The number of goods or services demanded changes much more than the price. Therefore the curve looks lower and flatter than the curve of unit elastic, which is diagonal.

Inelasticity of Demand

Inelasticity of demand is when people buy about the same amount of goods or services, whether the price drops or increases. It usually happens with necessary things like gasoline. Drivers need the same amount of petrol, whether the price increases or not. Similarly, they cannot buy more petrol when the price drops. Inelastic demand is one of the three types of elasticity of demand.

Inelastic Demand Curve

Since the quantity demand does not change as much as the price, it looks steep. You can also recognize the curve of inelastic demand by comparing it with the unit elastic curve. As the unit elastic curve is diagonal and inelastic demand curve is steeper. The demand for goods and services won’t shift, no matter what the price is.

Importance of Elasticity of Demand

Here are some critical points from which you can realize the importance of elastic demand.

1. Government Policies

Understanding of elasticity of demand is crucial for the formation of government policies, most importantly in taxation policies. If the demand for the commodity is elastic, then a rise in prices caused by the tax will bring about a significant decrease in the quantity demanded. Hence the government revenue will decrease.

2. Wage determination

The elastic demand influences the prices of production as well as the determination of wages. Its understanding is essential when a trade union demands a higher salary for the workers. The increase in the prices will raise the cost of the commodity. However, the decline in production will also lower the number of employees.

3. Economic Theories

The concept of elastic demand is also having significant importance in the economy. It is a tool of analysis to explain many economic problems and theories of price determination, especially under imperfect conditions and monopoly. Moreover, the relationship between price elasticity, marginal revenue, and average revenue in understanding price equilibrium.

4· Paradox of Plenty

It helps in explaining the paradox of plenty in agriculture. The productive crop harvested by farmers brings poverty instead of prosperity is known as the paradox of plenty. It happens due to the inelastic demand for most agricultural products. It means that when the supply of crops increases due to a good harvest, the prices decline due to demand decrease.

5· International Trade

The profits of international trade depend on elastic demand. A country gains more when the export goods with less elastic demand and imports goods for which demand is elastic. To fix the prices of products and services which have to export, the knowledge of elastic demand is crucial.

Thus the concept of elastic demand refers to the degree of responsiveness quantity of demanded goods to a change in its price or income.  And the price elasticity of demand is a measure of the change in its price.