What is Elasticity of Demand
Elasticity of demand is a measure of how a quantity of demand responds to a change in a related factor such as price, income, and cross-price. The elasticity of demand reflects how the quantity demanded is affected by the relative factor.
The elasticity of demand can be calculated by dividing the percentage change of quantity by the percentage change of a related factor. The most commonly used elasticity of demand is the price elasticity of demand which measure how a quantity of demand responds to a change in price. Higher elasticity number, the quantity responds more to related factors.
For example, the price elasticity of demand of 0.5 means that a 20% increase in price will lead to a 10% decline in the quantity demanded.
- Price elasticity of demand: The change in demand that is influenced by the change in price.
- Income elasticity of demand: The change in demand that is affected by the changes in income.
- Cross-price elasticity of demand: The responsiveness of demand to the change in prices of related goods.
Elasticity of Demand Formula
The elasticity of demand can be calculated with a similar equation by dividing the percentage change of quantity by the percentage change of a related factor, or the following equation:
E = Percentage change of quantity demand ÷ Percentage change of a related factor.
- Price elasticity of demand = Change of quantity demand ÷ Change of a change in price
- Income elasticity of demand = Change of quantity demand ÷ Change of a change in income
- Cross-price elasticity of demand = Change of quantity demand ÷ Change of a change in the price of related good
Additionally, there are five terms to describe elasticity from most to least elastic:
- Perfect elastic: Quantity responds hugely to changes in price (E = ∞)
- Elastic: The percentage change in quantity is more than the percentage change in price (E > 1).
- Unit elastic: The percentage change in quantity is the same as the percentage change in price (E = 1).
- Inelastic: The percentage change in quantity is less than the percentage change in price (E < 1).
- Perfectly inelastic: Quantity does not respond at all to changes in price (E = 0).
Elastic and Inelastic of Demand
The elasticity of demand can be classified be relative responsiveness by the terms elastic and inelastic.
The demand is elastic when the percentage change in quantity demand is greater than the percentage change in price (E > 1). In contrast, demand is inelastic when the percentage change in quantity demand is less than the percentage change in price (E > 1).
- Elastic (E > 1): The quantity demand changes much more than the price change.
- Inelastic (E < 1): The quantity demand doesn’t change much with a price change.
References: Federal Reserve Bank of St. Louis
