Definition of elasticity of demand and factors affecting it.

Introduction:

As the price of any commodity goes down, people start purchasing more quantity of it and as the price goes up, they purchase lesser of it. But the problem is how much of change in price leads to how much change in quantity demanded? If this problem is solved the seller would know how much of a quantity to be placed in the market with the respective change in price.

The concept of elasticity of demand solves this problem. It helps to measure the change in quantity demanded due to a given change in price. The concept is of great utility for producers, sellers, government, etc.

What is demand in economics?

" It is the various quantities of a given commodity or serve which consumers would buy in one market. In a given period of time, at various price or at various incomes, or at various price of related goods" (Bober)

Law of demand

"A raise in the price of commodity or service is followed by a reduction in demand, and a fall in price is followed by an increase in demand, provided the other condition (factors) of demand remains constant".

Law of elasticity of demand

The term expresses the degree of co-related between the demand and price. It can be explained as a measure of the relative change in amount purchased in response to a relative change in price on a given demand curve. A precise definition given by Mrs. John Robinson: "The elasticity of demand, at any price or at any output, is the proportional change of amount purchased in response to a small change in price, divided by the proportional change of price". Other things are assume to remain constant, e.g., other prices, consumers income etc. Other factors remaining constant, in some cases the small change in price leads to a bigger change in quantity demanded (e.g. luxury goods), where as in other cases, a big change in price leads to a very small change in quantity demanded. Very often a relative change in price leads to a higher or lesser change in the quantity demanded. This is due to the variation in the elasticity of demand. A little change in price leading to greater change in demand means higher elasticity of demand and vise-verse. There are some cases when any amount of change in price does not affect demand at all (necessary items, e.g. salt, medicines). This is called the inelastic demand. Thus, elasticity can be, ensured as per the response of demand towards change in prices.

There are five cases of elasticity of demand. They are 1,Perfect elastic or Infinite elasticity 2,Perfectly or Zero elasticity 3,Relatively Elastic 4,Relatively Inelastic 5,Unit Elasticity.

Factors affecting the Elasticity of Demand

There are some factors, which determine the responsiveness of demand due to change in the price of the commodity. Effect of these factors will explain weather the commodity is elastic or inelastic. Some of the following factors determine the elasticity of demand:-

1. Nature of the commodity: Commodities can be classified into necessities, comfort and luxuries. The consumers are more price sensitive to the comfort and luxuries in comparison to necessities. This is because even if the price of a necessary item increases or falls it has to be consumed e.g. salt, food, medicine etc. so they have less or inelastic demand. On the other hand the demand of comforts and luxuries can be postponed as and when the price changes and therefore more sensitive to price changes.

2. Number of close substitute: Larger the number of close substitute, greater in the elasticity of demand and vice-versa. In case of large number of substitutes, a little change in price will push the demand to other substitute goods and therefore, where as in case of no or lesser substitutes, the demand cannot be transferred to other goods and therefore less elastic demand.

3. Number of uses of the commodity: the commodity which can be put to different uses, have greater elastic then those, which have single use. A fall in price of the multi-use commodity to various applications and therefore highly elastic demand. Where as, in case of single use commodity, any fall in price will not lead to any increase in its demand doe to its limited use, therefore, less elastic demand.

4. Time period: Longer the time period, higher the elasticity and vice-versa. In the lo0ng period, the customer has sufficient time to wait for fall in price and therefore demand changes when the price of the commodity changes. In the short-time period there is no time to wait for price change. He has to purchase what ever price is available and therefore demand is less elastic.

5. Price level: Elasticity of demand is high for the commodities at higher price levels and the low prices commodities mostly have low elasticity. It is because the cheap goods do not effect the pocket of an individual much, he is less bothered about the change in its price where as the costly items have great effects on the pocket of an individual.

6. Postponement of the use of goods: if there are possibilities of postponing the consumption of the goods (but wherever the price are suitable) its demand is highly elastic. On the other hand if the goods have to be consumed immediately the demand is less elastic as one has to demand at the available price e.g., medicines.

7. Proportion of total expenditure on that commodity: Large the proportion of total expenditure, spent on a commodity, higher will be the elasticity of the commodity and vice-versa. The reason being that a fall in price of such expenditure leads to a substantial amount saved (e.g. fall in price of milk) which can be used to fulfil other demands. On the other hand, if the proportion of expenditure is little there is hardly any effect due to change in price e.g. candle, soap, etc.

8. Income of commerce: Price elasticity of demand for very high & low income group people for any commodity is generally inelastic because the change in price does not affect the rich pocket and the poor have very scarce demand for necessities only. The middle-income group has elastic demand as they are more sensitive to price change.

9. Nature of demand: Demand of related goods is generally elastic e.g. demand of substitute goods is elastic, because the quantity demanded is more responsive to price change. On the other hand, demand of complementary goods is determined by the nature of the complement goods e.g. if the demand for car is elastic then the demand for petrol will also be elastic. On the other hand if the demand is related to habitual goods, then elasticity of demand is less as these goods will be consumed be at what so ever prices.

Relationship between price elasticity of demand, average revenue (AR) and marginal revenue (MR)

When the MR is positive or the TR is increasing as the price is reduced the elasticity of demand is greater than one. This means that when the price of elastic (E>1) commodity is reduced: the demand will increase in such a way that the total revenue increase at a higher rate and therefore the marginal revenue is positive. When the MR=O and the total revenue is at maximum and constant (the change in price do not effect TR) the elasticity is zero. This means that when the price of the commodity change, the demand changes in such a way that there is no change in total expenditure of total revenue. Therefore MR remains at zero. When MR= negative and the total revenue is falling, the elasticity is less that one. This means that when the price of the commodity falls, the total expenditure or TR also fall due to inelasticity of goods. Therefore for MR is negative.