Elasticity of Demand
Elasticity of demand measures the responsiveness of the quantity demanded of a good or service to a change in one of its determinants, most commonly its price. It is a central concept in microeconomics, used to analyse how markets react to changes in prices, incomes, and the prices of related goods.[1]
Price elasticity of demand
The price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price:
- PED = (% change in quantity demanded) ÷ (% change in price)
Because quantity demanded generally falls when price rises, the price elasticity of demand is usually negative, and it is often reported in absolute value.[1]
Categories
| Value | Category | Meaning |
|---|---|---|
| PED| > 1 | Elastic | Quantity changes proportionally more than price. |
| PED| = 1 | Unit elastic | Quantity changes proportionally to price. |
| PED| < 1 | Inelastic | Quantity changes proportionally less than price. |
| PED| = 0 | Perfectly inelastic | Quantity does not change with price. |
| PED| = ∞ | Perfectly elastic | Any price increase reduces quantity to zero. |
Determinants
The elasticity of demand depends on several factors, including the availability of substitutes, the proportion of income spent on the good, whether the good is a necessity or a luxury, and the time horizon. Goods with close substitutes, luxury goods, and goods that account for a large share of income tend to have more elastic demand; necessities and goods with few substitutes tend to be inelastic.[1]
Other elasticities
| Type | Measures |
|---|---|
| Income elasticity of demand | Responsiveness of demand to changes in consumer income. |
| Cross elasticity of demand | Responsiveness of demand for one good to the price of another. |
| Elasticity of Supply | Responsiveness of quantity supplied to price. |
Importance
Elasticity is important for firms in setting prices and for governments in designing taxation and policy. When demand is inelastic, a tax raises revenue with little reduction in quantity; when demand is elastic, the same tax leads to a larger fall in quantity. Elasticity also determines who bears the burden of a tax—the more inelastic side of the market bears a larger share.[1]