ELASTICITY OF DEMAND

The law of demand tells us that consumers will respond to a price change by buying more or less of a product.  The law of demand does not exactly indicate the degree of responsiveness of consumers to a price change. If the price of a product falls, consumes will buy more and vice versa. This responsiveness of the quantity demanded of a commodity to the changes in determinants is known as elasticity of demand. 

The concept of elasticity of demand not only tells that consumer’s demand responds to price changes but also the degree of responsiveness of consumers’ demand. Elasticity of demand is explained as the ratio of the percentage change in quantity demanded to the percentage change in the demand determinant under consideration. The concept can also be explained in percentage terms. In percentage terms, elasticity is a percentage relationship between two variables, i.e. percentage change in one variable relative to a percentage change in another variable.

                                     

Once the coefficient of elasticity is worked out, the task remains to interpret the coefficient and to determine the effects of the change. There are various methods of measuring elasticity of demand as well as different concepts of demand elasticity. These include: (i) Price elasticity, (ii) Income elasticity, (iii) Cross elasticity, and (iv) Advertising elasticity and, (v) Elasticity of price expectation

Importance of the Concept of Elasticity

The idea of the elasticity of demand possesses great practical value for business executives.

1.      The businessman especially if he is a monopolist will have to consider the nature of demand while fixing his price. In case he faces inelastic demand curve, I will pay him to charge a higher price and sell a smaller quantity. If the demand for the monopolist’s product is elastic, he will reduce the price and sell more in order to maximize his monopoly net revenue.

2.      The concept of elasticity of demand finds application in the case of combined products. In such cases, separate costs are not determined. The producer will be guided mostly by demand and its nature while fixing his price. The transport authorities also fix their rates according to the elasticity of demand.

3.      When the increasing returns are operating in an industry, the manufacturer reduces the price to develop the market so that he may be able to produce more and take full advantage of the economies of large scale production.

4.      Elasticity of demand also exerts its influence on wages. If demand for particular type of labor is relatively elastic, it is easy to raise wages.

5.      The concept is also used in explaining the determination of price under various market situations. For example, under perfectly competitive market, the demand curve facing an individual seller is perfectly elastic which means that the producer can sell any amount by lowering the price a bit. But under monopoly or imperfect competition, the demand is less than perfectly elastic and the demand curve is downward sloping. Since the demand is less elastic, the monopolist is in a position to exercise some control over price.

6.      The Finance Minister of a country can be sure of his revenues if he taxes those commodities for which the demand is inelastic.

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