Concept of Elasticity of Demand
Elasticity of demand measures how the quantity demanded of a commodity responds to changes in various factors. It is calculated as the percentage change in quantity demanded divided by the percentage change in one of the influencing variables.
Types of Elasticity of Demand
- Price Elasticity of Demand (PED)
- Definition: Measures the responsiveness of the quantity demanded to changes in the price of the commodity.
- Formula:
- Interpretation:
- PED>1: Demand is elastic (sensitive to price changes).
- PED<1: Demand is inelastic (less sensitive to price changes).
- PED=1: Unit elastic demand.
- Income Elasticity of Demand (YED)
- Definition: Measures the responsiveness of the quantity demanded to changes in consumer income.
- Formula:
- Interpretation:
- YED>0: Normal goods (demand increases as income increases).
- YED<0: Inferior goods (demand decreases as income increases)
- Cross Elasticity of Demand (XED)
- Definition: Measures the responsiveness of the quantity demanded of one good to changes in the price of another good.
- Formula:
- Interpretation:
- XED>0: Substitutes (increase in the price of B increases demand for A).
- XED<0: Complements (increase in the price of B decreases demand for A).
- Advertisement or Promotional Elasticity of Sales
- Definition: Measures the responsiveness of the quantity demanded to changes in advertising or promotional efforts.
- Formula:
- Where:
- 𝑒𝐴 is the advertisement or promotional elasticity of sales.
- Δ𝑆 is the change in sales.
- Δ𝐴 is the change in advertising expenditure.
- 𝐴 is the initial advertising expenditure.
- 𝑆 is the initial sales.
- Interpretation: Higher values indicate more effective advertising.
- Elasticity of Price Expectations
- Definition: Measures the responsiveness of the quantity demanded to changes in expected future prices.
- Formula:
- There isn’t a specific formula widely used for this elasticity, but it’s conceptualized similarly to PED.
- Interpretation: If consumers expect prices to rise in the future, current demand may increase, and vice versa.
Key Points
- Elasticity helps businesses and policymakers understand consumer behavior and make informed decisions.
- High elasticity indicates greater sensitivity to changes, which can impact pricing strategies, tax policies, and marketing efforts.
- Different types of elasticity provide insights into various factors affecting demand, not just price.
Understanding these types of elasticity can significantly aid in optimizing pricing, forecasting sales, and strategizing marketing efforts.