By now we have already come to know from the law of demand that, when the price of a good increase, the quantity demanded falls, other things remaining the same. But, this information is not of much practical use since we know only the direction of change in the demand for a given change in the price. If we know the magnitude of this change, it will help a lot in our decision-making. In this chapter we will make an effort to understand the extent to which the quantity demanded will rise (fall) due to a fall in the income of the consumer. This involves an analysis of demand sensitivity with respect to prices of goods and income, which helps the business to forecast market trends for the future.
Supply explains the functional relationship between price and quantity demanded and price and quantity supplied respectively. These laws explain the directional change in he demand & supply and do not measure the magnitude of change in demand and supply. The elasticity of demand and supply measure the magnitude of change. These concepts of elasticity are used in day-to-day business life.
The demand of a commodity will change whenever there is a change in price. Sometimes the demand for a commodity is so sensitive that even a small change in price will bring about a large change in the quantity demanded (i.e. the demand is elastic). In general, demand elasticity is simply a measure of relative responsiveness of quantity demanded to changes in one of the determinants assumed as unchanged. To be specific, elasticity is defined as the ratio of the percentage change in quantity demanded to the percentage change in the demand determinant under consideration. Thus the elasticity of demand is
Where the Determinant Z may be one of the following:
- Price of the commodity (Px)
- Prices of the related goods (Pr)
- Income of the household (y)
On the basis of these determinants the elasticity of can be of following types
- Price elasticity of demand;
- Income elasticity of demand; and
- Cross elasticity of demand;
Elasticity of demand may be defined as the degree of responsiveness of demand to a change in its determinants viz. Price of that commodity, income of the consumer, price of the substitutes and price of complements etc. It shows the degree to which demand stretches or contracts as a result of a change in its determinants.
“The elasticity of demand in a market is great or small according as the amount demanded increases much or little for a given fall in price and diminishes much or little for a given rise in price – Alfred Marshall
Elasticity of demand is the ratio of a relative change in demand to a relative change in its determinants. If we denote elasticity bye, them elasticity of demanded is,
ed = Relative change in quantity demanded corresponding relative change in its determinants.