Price Elasticity of demand serves to determine just how responsive quantity demanded is to changes in price. It is defined as the percentage change in quantity demanded divided by the percentage change in price, that is,
If customer demand is very responsive to a change in price, the response is said to be elastic. This occurs where elasticity calculated using the above formula is greater than 1. This also implies that the demand curve is relatively flat as demonstrated below.
The figure above shows an elastic demand curve.
The response is deemed inelastic when the elasticity is calculated to be less than 1 and when the demand curve is steep as shown below.
The figure above shows an inelastic demand curve.
The determinants of price elasticity of demand are:
- The availability of substitutes: the more substitute goods available, the greater the elasticity of that good.
- Degree of necessity: goods of necessity are inelastic, while luxury goods are elastic.
- Time period: elasticity is generally higher in the long run than in the short run.
Income elasticity shows how changes in consumer income affect the quantity of products demanded. It is defined as the percentage change in quantity demanded to the percentage change in income.
Cross elasticity of demand measures how the demand for a good is affected by the change in price of another good. It is defined as the percentage change in quantity X demanded/ the percentage change in price of Y. The cross elasticity of demand also determines whether goods are complements (used together) or substitutes (used instead of each other). If the cross elasticity is negative, they are complements, if positive, they are substitutes.
The price elasticity of supply measures the response of quantity supplied to a change in price. It is defined as the percentage change in quantity supplied to the percentage change in price. The price elasticity of supply, like demand, deems a change elastic if the elasticity is greater than 1 and in this case the supply curve is flat.
The figure above shows an elastic supply curve.
The reaction is inelastic if the elasticity is less than 1 and the supply curve is steep.
The figure above shows an inelastic supply curve.