Similar in meaning to the expansion of a rubber band, elasticity of demand refers to how changes in X (which can be anything such as price, income, etc.) can affect the quantity demanded. The most commonly known and easily understood type of elasticity of demand is the price elasticity of demand (PED). In PED, we look at how changes in price can affect the quantity demanded. Other types of demand elasticity such as income elasticity of demand and cross elasticity of demand look at how variables such as income and prices of other related goods can affect quantity demanded. The following article takes a closer look at price elasticity of demand and other elasticity of demand and explains their similarities and differences.
Price Elasticity of Demand
Price elasticity of demand shows how changes in demand can occur with the slightest change in price. Price elasticity of demand is calculated by,
PED = % change in the quantity demanded / % change in the price.
There are different levels of elasticity depending on how responsive quantity demanded is to change in price. If PED=0, this shows perfectly inelastic situation where demand will not change at all with any changes in price, examples are necessities and addictive goods. If PED is less than 1, this is still inelastic because, change in quantity demanded is lower than respective change in price (large change in price will result in a small change in quantity demanded). If PED is greater than 1, this shows price elastic demand where, a small change in price will result in a large change in quantity demanded, examples are luxury goods and substitute goods. When PED=1, the change in price will have an equal change in quantity demanded which is called unitary elastic.
Elasticity of Demand
There are other types of demand elasticity, such as cross elasticity and income elasticity. Cross elasticity is when the change in the price of one product can result in a change in the quantity demanded of another. Such cross elasticity occurs between goods that are related to one another, and maybe substitute goods such as butter and margarine, or complimentary goods such as pencils and erasers. As for substitute goods, when the price of butter increases the demand for margarine will increase as consumers can now use margarine instead of butter (assuming the price of margarine stays the same). With complimentary goods, when the price of pencils increase the demand for pencils as well as erasers will fall (since erasers are useless without pencils).
Income elasticity of demand measures how changes in income can affect demand; assuming that the price of the good does not change. As income increases demand for necessities and luxuries will increase. However, demand for inferior goods will decrease as income increases because consumers will be able to purchase better quality goods instead of purchasing cheap inferior ones.
Elasticity of Demand vs Price Elasticity of Demand
Elasticity of demand shows how changes in price of a product, price of a related product, or income can affect the quantity demanded. The article looked at 3 main types of demand elasticity that are similar because the increase or decrease in any of the 3 factors explained can either increase or decrease quantity demanded. The difference is that, for PED, we consider how the price of a product itself can affect the demand whereas, in the cross and income elasticity, we consider how other factors such as income and price of related products can affect demand.
Summary:
• Price elasticity of demand shows how changes in demand can occur with the slightest change in price. Price elasticity of demand is calculated by, PED = % change in the quantity demanded / % change in the price.
• Cross elasticity is when the change in price of one product can result in a change in the quantity demanded of another related product.
• Income elasticity of demand measures how changes in income can affect demand; assuming that the price of the good does not change.