ELASTICITY OF DEMAND

Elasticity of demand is defined as the degree of responsiveness of quantity demanded of a

commodity to changes in the commodity’s own price, income of consumers and prices of
related commodities.

A. Price Elasticity of Demand

Price elasticity of demand is the degree of responsiveness of quantity demanded of a
commodity to changes in price of the commodity in question.

Determinants
- The availability of substitutes; the demand for a commodity is more elastic if
there are close substitutes for it.
- The nature of the need that the commodity satisfies. In general, luxury goods are
price elastic, whilst necessities are price inelastic.
- The time period. Demand is more elastic in the long run.
- The number of uses of the commodity. The more the possible uses of a
commodity, the more inelastic the commodity will be.
- The proportion of income spent on the commodity. The more the income spent on
a commodity, the more elastic the commodity will be.

Price Elasticity of Demand

Price elasticity of demand can be defined as a measure of the responsiveness of demand
to changes in the commodity’s own price. This could be measured in two ways:

- Point elasticity
- Arc elasticity

i. Point elasticity
This measures elasticity at a particular point on the demand curve. That is:

Price Elasticity of Demand (ep) = ∆Q × P

∆P Q

Note: ∆Q = change in quantity demanded of the commodity

∆P = change in price of the commodity
Q = initial quantity demanded, and
P = initial price

It must be noted that price elasticity is always negative because of the inverse relationship
between the quantity (Q) and the price (P) by the ‘law of demand’. However, traditionally

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the negative sign is always omitted when writing the formula of the elasticity (ie only the
absolute values are considered).

The range of values of the elasticity are:

0 ≤ ep ≤ ∞

- If ep = 0, the demand is perfectly inelastic.

- If ep = 1, the demand has unitary elasticity.
- If ep = ∞, the demand is perfectly elastic.
- If 0 < ep < 1, we say that the demand is inelastic.
- If 1 < ep < ∞,we say that the demand is elastic.

[Diagram 1]

Elastic Demand
Demand is elastic when a small proportionate/percentage change in price leads to more
than proportionate/percentage change in quantity demanded. For instance a 10% change
in price leading to 70% change in quantity demanded means the elasticity coefficient
(ep), either point or arc, will be greater than one. A small fall in price leads to a more
than proportionate increase in quantity demanded. Goods that have elastic demand may
include milo, soft drink, milk and soap (these are goods that have close substitutes).

Inelastic Demand
Demand is inelastic when a greater proportionate/percentage change in price leads to less
proportionate/percentage change in quantity demanded. For instance a 60% change in
price leads to a 10% change in quantity demanded means the elasticity coefficient (ep )
either point or arc, will be less than one. A great increased in price leads to a lesser than

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proportionate fall in quantity demanded. Goods that have inelastic demand include
cigarettes, beer, guinness, water, food (these goods are goods of necessity or habit
forming goods).

Unitary Elastic Demand

When a proportionate/percentage change in price leads to equal proportionate/percentage
change in quantity demanded price elasticity of demand is said to be unitary elastic. For
instance a 30% change in price resulting in 30% change in quantity demanded. The
elasticity coefficient (ep) either point or arc will be unitary (equal to one). The demand
curve of unitary elastic demand slope gently as shown below. Goods that have elastic
demand include the normal goods such as biscuits, pens etc.

Perfectly Inelastic / Zero Elastic demand

Perfectly Inelastic demand occurs when proportionate/a percentage change in price
induces no proportionate/percentage change in quantity demanded For instance a 30%
change in price resulting in 0% change in quantity demanded. The elasticity coefficient,
either point or arc is zero. The demand curve of perfectly inelastic demand is vertical as
shown below. Goods that exhibit perfectly inelastic demand may include water, salt and
food (these are goods of necessity of which we cannot live without).

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Perfectly elastic /infinitely elastic demand
Perfectly elastic demand occurs when price does not change yet there is proportionate/a
percentage change in quantity demanded. For instance a 0% change in price resulting in
50% change in quantity demanded. The elasticity coefficient, either point or arc is
infinite. The demand curve of perfectly elastic demand is horizontal as shown below.
Goods that have perfectly elastic demand may include agricultural produce (these are
goods which are produced by uncountable producers).

Illustration 1:
 Using the demand curve and the demand schedule below, the point elasticity
coefficients as price changes are calculated below:

Price
($per unit)

A
80

B
60

40 C

D
20
D
10 20 30 40
Quantity
0 0 0 0
(per time
period)

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 Point Price Quantity Point Elasticity Arc (mid point)
$ Demanded coefficient elasticity
coefficient
A 80 100 - -
B 60 200 4 2.3
C 40 300 1.5 1.0
D 20 400 0.67 0.42

• ep at point B (change in price from $80 to $60) is

∆Q = 200-100 = 100
Q = 100
∆P = 60-80 = -20
P = 80

Therefore ep = 100 × 80 = -4 (ep = 4 demand is elastic)

-20 100

• ep at point C (change in price from $60 to $40)

∆Q = 300-200 = 100
Q = 200
∆P = 40-60 = -20
P = 60

ep = 100 × 60 = -1.5 (ep = 1.5 demand is elastic)

-20 200

• ep at point D is (change in price from $40 to $20)

∆Q = 400-300 = 100
Q = 300
∆P = 20-40 = -20
P=40

ep = 100 × 40 = -0.67 (ep = 0.67 demand is inelastic)

-20 300

Note: The negatives attached to the elasticity coefficients are due to the negative slope of
the normal demand curve or the inverse relationship between price and quantity
demanded and therefore are always omitted.

ii. Arc elasticity

If the changes in the price are not small we use the arc elasticity of demand as the
measure. The arc elasticity is a measure of the average elasticity, that is, elasticity at the
mid-point of two elastic points on a demand curve.

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It is change in quantity demanded divided by mid-point of arc quantity demanded divided
by change in price divided by mid point of arc price.

ep = ∆Q × (P1+P2)/2
∆P (Q1+Q2)/2

= ∆Q × P1+P2
∆P Q1+Q2

Illustration 2
 Using the demand curve and the demand schedule above ,the Arc (mid point)
elasticity coefficients as price changes are calculated below;
• Arc (mid point) elasticity between Point A and B i.e. a change in price from $80 to
$60
• ∆Q =200-100=100
• Mid point between Q1 and Q2 =(200+100)/2=150
• ∆P =60-80=-20
• Mid point between P1 and P2 =(60+80)/2=70
• Therefore Arc (mid point) elasticity between Point A and B is

100 × 70 = -2.3 (ie 2.3 demand for the price range is elastic)
-20 150

• Arc (mid point) elasticity between Point B and C i.e. a change in price from $60 to
$40
• ∆Q =300-200=100
• Mid point between Q1 and Q2 = (300+200)/2=250
• ∆P = 40-60 = -20
• Mid point between P1 and P2 = (40+60)/2=50
• Therefore Arc (mid point) elasticity between Point B and C is
100 × 50 = -1.0 (ie 1.0 demand for the price range is unitary)
-20 250

• Arc (mid point) elasticity between Point C and D i.e. a change in price from $40 to
$20
• ∆Q =400-300=100
• Mid point between Q1 and Q2 = (400+300)/2=350
• ∆P =20-40=-20
• Mid point between P1 and P2 = (20+40)/2 = 30
• Therefore Arc (mid point) elasticity coefficient between Point C and D is

100 × 30 = -0.42 (ie 0.42 demand for the price range is inelastic)
-20 350

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Note: The negatives attached to the elasticity coefficients are due to the negative slope of
the normal demand curve or the inverse relationship between price and quantity
demanded and are always omitted.

Importance of Price Elasticity of Demand

a. Incidence of taxes
This refers to effects of taxes and where the burden finally rest. Price elasticity of
demand can help determine who bears the tax burden especially producer and
consumer. If a tax is imposed on a producer, s/he will bear all, passed all the tax to
consumer or share with the consumer depending on price elasticity of the good. If the
good has perfectly elastic demand, producer bears the entire tax burden. If the good has
perfectly inelastic demand, consumer bears the entire tax burden. If the good has
inelastic demand, consumer bears more of the tax burden than consumer. If the good
has elastic demand, producer bears more of the tax burden than consumer. If the good
has unitary elastic demand, producer and consumer bear the same burden.

b. A guide to pricing
Goods that have inelastic demand can be priced high to increase sales revenue as a
higher percentage increased in price leads to less percentage fall in quantity demanded.
Goods that have elastic demand should be priced low to increase sales revenue as a
small percentage fall in price leads to more percentage increased quantity demanded.

c. A guide to taxation
Government can levy high taxes on goods that have inelastic demand to raise more
revenue. This is because a higher percentage increased in price of such commodities
leads to less percentage fall in quantity demanded. Good that have elastic demand
should attract low taxes. This is because a small fall in price can lead to more than
proportionate increased in quantity demanded which can result in increased government
revenue.

d. A guide to devaluation
Currency devaluation is a reduction in the rate of a currency in relation to other
currencies to help solve balance of payment problems. Devaluation makes exports
cheaper and imports more expensive and this can help correct adverse balance of
payment. For devaluation to be successful both imports and exports must be elastic. If
exports are elastic a small fall in prices of the exports can lead to more than
proportionate increased in quantity demanded of exports which can result in increased
foreign exchange to help correct the balance of payment difficulties. If imports are
inelastic balance of payment problem worsens as a greater increased price lead to less
than proportionate fall in demand.

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Income Elasticity of Demand
The Income elasticity is defined as the proportionate change in quantity demanded
resulting from a proportionate change in income of the consumer. Symbolically we may
write

Income Elasticity of demand (em) = Proportional Change in quantity demanded

Proportional Change in income

Where:
Proportional Change in quantity demanded = ∆Q/Q
Proportional Change in income = ∆M/M

Therefore em = ∆Q/Q÷∆M/M

=∆Q × M
∆M Q

Note: ∆Q = Current quantity demanded-Previous quantity demanded

Q = Previous quantity demanded
∆M = Current income-Previous income
M = Previous income
Illustration 3z

Income ($) Quantity Income Elasticity

Demanded coefficient
8,000 100 -
10,000 200 4
12,000 220 0.5

 Using the table above, calculate the income elasticity coefficients

• em (as income increases from $8000 to $10000) is

∆Q = 200-100 = 100
Q = 100
∆M = 10000-8000 = 2000
M = 8000

Therefore em =100 × 8000 = 4 (Income is elastic)

2000 100

• em as income increases from $10000 to $12000

∆Q = 220-200 = 20
Q = 200
∆Y = 12000-10000 = 2000
Y = 10000

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 Therefore em = 20 × 10000 = 0.5 (Income is inelastic)
2000 200

Types of Income Elasticity of Demand

e. Income Elasticity for Normal goods

If a consume r’s income increases and s/he buys more of a good, then such a good is a
normal good. The income elasticity coefficient of the good is positive. However, such a
good could be income elastic or income inelastic depending on the degree of
responsiveness of quantity demanded to changes in the income of the consumer.

f. Income Elasticity for inferior goods

If a consumer’s income increases and s/he buys less of a good then the good is an inferior
good. Normally such a good has negative income elasticity coefficient. ‘gari’ could be
an inferior good to some people.

g. Income Elasticity for goods necessity.

If a consumer’s income increases and s/he buys the same amount of the good, then the
good is a necessity. Normally such a good has zero income elasticity coefficient. Eg.
may be salt.

Cross Elasticity of Demand

Cross elasticity of demand is the degree of responsiveness of quantity demanded of a
good to changes in the price of a related good.

Cross elasticity of demand (exy ) = Proportional Change in quantity demanded of a good

Proportional Change in the price of a related good

Where:
Proportional Change in quantity demanded of good X= ∆Qx/Qx
Proportional Change in price of a related good = ∆Py/Y

exy = ∆Qx/Qx÷∆Py/Py

or
= ∆Qx × Py
∆Py Qx

∆Qx = Current quantity demanded of X - Previous quantity demanded of X

Qx = Previous quantity demanded of X
∆Py = Current price of good Y - Previous price of good Y
Py = Previous price of good Y

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Price of Quantity Demanded Cross Elasticity
good Y ($) of good X coefficient
80 100 -
100 200 0.40

 Using the table above ,the cross elasticity coefficients as price of good Y
Changes are calculated below;
• exy as price of good y increases from $80 to $100 is
∆Qx = 200-100 = 100
Qx = 100
∆Py = 100-80 = 20
Py=80

exy = 100 × 80 = 0.40 (cross inelastic)

20 100

Types of Cross Elasticity of Demand

h. Cross Elasticity of substitutes

If an increased in the price of good Y leads to increase in demand of good X then good Y
and good X are substitutes. The cross elasticity coefficient of the two goods is positive.
Eg. milo and bournvita.

i. Cross Elasticity for complements

If an increased in the price of good Y leads to a fall in demand of good X then good Y
and good X are complements. The cross elasticity coefficient of the two goods is
negative. E.g. A car and petrol.

j. Cross Elasticity of goods with no relations

If an increased in the price of good Y leads to no change in demand of good X then good
Y and good X are not related. The cross elasticity coefficient of the two goods is zero.
Eg. sandals and pen.

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Try Questions:

1. Use the table below to answer the questions that follows;

Price Quantity Elasticity a. Use the arc (mid point) elasticity formula
($) demande coefficient to calculate the elasticity coefficient when
d price changes from
100 30 i. ($) 100 to ($)90
90 40 ii. ($)70 to ($)60
80 50 1.89 iii. ($)50 to ($)40
70 60 1.36 b. Which of the three price ranges in question
60 70 (a) above has
i. Elastic demand
50 80 0.73
ii. Inelastic demand
40 90
iii. Unitary elasticity?
c. Which other formula can be used to
calculate elasticity coefficient?

2. Use the data to answer the questions that follow;

Commodities Price($) Quantity a. Using the point elasticity formula,
demanded calculate the price elasticity of
demand for commodities
X 20 50 (i) X
12 60 (ii) Y
Y 24 40 (iii) Z
20 50 b. Interpret your answers in (i),(ii)
and (iii)
Z 22 40 c. Define price elasticity of demand
20 50 d. Give any two uses of price
elasticity of demand

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