1

THE ELASTICITY OF DEMAND:- A CRITICAL ANALYSIS

Submitted by
Mohit Singh

Teacher In-charge
Mr. Nayan Jyoti Pathak

NATIONAL LAW UNIVERSITY, ASSAM

OCTOBER 27TH, 2015

TABLE OF CONTENTS
CONTENTS

PAGE NO.

1. Introduction
1.1.
Overview
1.2.
Literature Review
1.3.
Research Questions
1.4.
Scope and Objectives
1.5.
Research Methodology

3-5

2. The Elasticity of Demand

2.1.
The Concept of Demand
2.2.
The Concept of Elasticity
2.3.
Factors influencing the Elasticity of Demand

5-8

3. Types of Elasticity of Demand

3.1.
Price Elasticity of Demand
3.1.1.1.
Perfectly elastic
3.1.1.2.
Perfectly inelastic
3.1.1.3.
Unitary elastic
3.1.1.4.
Highly elastic
3.1.1.5.
Less elastic
3.2.
Income Elasticity of Demand
3.2.1.1.
Zero income elasticity
3.2.1.2.
Negative income elasticity
3.2.1.3.
Unitary income elasticity
3.2.1.4.
Income elasticity of demand greater than unity
3.2.1.5.
Income elasticity of demand less than unity
3.3.
Cross Elasticity of Demand

9-15

4. Uses of Elasticity of Demand

16

5. Conclusion

17

Select Bibliography

18

CHAPTER-1
INTRODUCTION
1.1.

Overview

The Elasticity of Demand refers to any change in the demand as a result of change in
factors which influences demand. Demand is the actual amount of commodity that any
consumer willing to buy at various prices over a particular period of time. The demand of
any commodity or product in the market underwent through a number of changes due to
various factors which are prevailing in the market. A slight change in any one of the
factors might led to the change in the demand of a particular product. The demand
offered by the consumers is subject to their income and tastes. For a person, whose
income is high might not have much problem with the price factor while making a
demand. But the same factor may affect any other person who is not rich. Demand of a
commodity is highly subjective with different income group people and with their
different tastes and preferences. The Elasticity of Demand is a concept which tells us the
changes in demand in a quantified manner. Since it is very difficult for us to measure
tastes and preferences of a person and his future expectations. So the Elasticity of
demand, in order to give us results, focuses on three factors. These factors are price of the
commodity, income of buyer and relative products or substitute products available in the
market. On the basis of these factors Elasticity of Demand is divided into three parts i.e.
price elasticity of demand, income elasticity of demand and cross elasticity. This work
deals with the abovementioned types of elasticity of demand. It also provides us insights
of the factors which affect the demand of the consumer. This project gives us the different
processes of measurements which is used by the industries and companies to check the
demand in the market. This piece of work will give us the detailed study of the types,
factors and measurement process of the elasticity of demand with its analysis by
supplying certain examples.

1.2.

Literature Review
Vzquez, Andrs. A New Approach To The Price Elasticity Of Demand, EGEA SPA, Anno
52, No. 1/3 (Gennaio-Marzo 1993), pp. 125-132, accessed on august 5 th,2015, available in
Jstor

In this paper, the author develops a new approach to the price elasticity of demand, which
comes naturally and gets support from the genesis of the concept itself, originally defined for
the purpose of explaining the behavior of total revenue at alternative prices. The paper is
organized as follows. In Section 1, we present an alternative representation of the point
elasticity of demand in connection with total revenue changes. In Section 2, the author
introduces and analyzes the equivalent measure for the elasticity of demand. A theorem
ensures that it equals the point demand elasticity at some point inside the interval, thereby
leading to the exact estimation of the point demand elasticity when this is Constant. If, on the
other hand, the demand curve is linear, then are elasticity reduces to the familiar formula
proposed by Alien (1934). Section 3 shows that the relationships between the elasticity of
demand and the revenue elasticities are formally parallel to those derived for the point
elasticity case. Finally, Section 4 contains some brief concluding remarks.
Witztum, Amos. Economics: An Analytical Introduction, New York: Oxford University
Press, (2005)
Witztum's text is a robust and challenging introduction to the key principles of economics. It
delivers a comprehensive and focused view of the logical core of economic analysis.
Presented in a clear and accessible form, the content is nonetheless sufficiently developed to
take students beyond mere fundamentals, teaching them to apply economic theories and
models to recognisable, real life examples. The book is therefore able to prepare students for
further study of economics rather than to simply acquaint them with basic concepts. The
numerous exercises, questions and model answers are designed to help students better
understand the relationship between models and reality. Its pure and clean, no nonsense
approach quickly takes the reader to this point of understanding.

Maddala, G.S., Microeconomics: Theory and Applications, Tata McGraw-Hill, (2004)

Special features of the book include: the book offers exceptionally patient and careful
coverage of the core topics in microeconomics; in-depth coverage of many topics from
current microeconomic research; the book presents microeconomics in the context of its
historical development, both in giving the development of core topics and explaining modern
research; it features many innovative examples and applications of micro-economic theory;
in-depth coverage of welfare economics for instructors who want to include this material in

courses. Chapter three of this book deals with the price elasticity of demand and supply. It
deals extensively with all the concepts of the price, income and cross elasticity of demand.
1.3.

Research Questions
1. What are the conditions that make a consumer change his demand in the market?
2. What is the role of the elasticity of demand in the market structure and its actors?

1.4.

Scope and Objectives

The scope of this project is limited to the study of demand and its elasticity. It is limited to
the factors which caused the change in demand of the products due to the change in the
factors.
The objectives which is tried to achieve are:a. To understand the role of the factors which influence the elasticity of demand.
b. To analyze the different types of the elasticity of demand.
c. To understand the importance of elasticity of demand in real world.

1.5.

Research Methodology
In this project, the researcher has adopted Doctrinal type of research. Doctrinal research is
essentially a library based study, which means that the materials needed by a researcher may
be available in libraries, archives and other data bases. Various types of books were used to
get the adequate data essential for the project. The researcher also used computer laboratory
to get important data related to this topic. Several websites found to be very useful to better
understand this topic.

CHAPTER-2
THE ELASTICITY OF DEMAND
2.1.

The Concept of Demand

Demand for a good is defined as the quantity of the good purchased at a given price at given
time. Demand is the first law of purchase.
The demand for any things, at a given price is the amount of it which will be bought per unit
of time at that price.1

- Benham

It is the purchasing power capacity of the consumer. It is the desire backed by the ability to
purchase. Desire and demand is something different concepts in this regard. Anyone can
1 Chatterjee, Ratna., An Introduction to Economics for pre-law students, Central Law Publications,
(2006), p.34

desire any good or service. But just by desiring something, one cannot have it without paying
the price. Once the price is paid by the person who has desired it, only then it becomes the
demand for the good by that person.
For an example, A purchased 2 kg of mangoes at Rs. 50 per kg last week. This is the
demand for mangoes by A. Had A desired to have mangoes but could not pay the price to
buy, then it would have been said as As desire but not demand for mangoes.
Individual demand refers to the quantity of a commodity that an individual buyer is willing to
buy at given price per unit of time. But how much quantity of a commodity one is willing to
buy depends upon the following factors. These are also called determinants of demand. These
are price of the commodity (P), Price of related goods (Pr), Income of the buyer (Y), Tastes
and preferences of the buyer (T) and future expectations (F). These factors are explained in
detail in next chapters of this work.
The analysis of the functional relationship between the demand of a commodity and its
determinants is known as the law of Demand. That is why that in normal condition slope of
the demand curve is downward left to right and convex to the origin.
So, it can be expressed as Q = f( P, Y, T, Pr, F).
The Law of Demand states that Ceterius paribus (all other things remaining constant), the
quantity demanded of a commodity rises with a fall in price, and falls with a rise in price.2
So, it is the inverse relation between quantity demanded and the price of the commodity.
Demand for a commodity is affected by a number of factors like change in its own price,
change in the income of the consumer, change in the price of related goods, etc. Elasticity of
demand refers to the percentage change in demand for a commodity with respect to
percentage change in any of the factors affecting demand for that commodity.3
2 Mittal, Abha., Micro Economics theory and applications, taxmann Publications (P.) Ltd, (2nd edition),
p.9
3 Garg, Sandeep., Introductory Microeconomics, Dhanpat Rai Publications, (4 th revised edition, 2013), p.
4.2

Elasticity of demand can be calculated as:

Elasticity of demand =

Percentage change in demand for X

Percentage change in a factor affecting the demand for X

2.2.
The Concept of Elasticity of Demand
Elasticity refers to the degree of responsiveness in supply or demand in relation to changes in
price. If a curve is more elastic, then small changes in price will cause large changes in
quantity consumed. If a curve is less elastic, then it will take large changes in price to effect a
change in quantity consumed.4 Graphically, elasticity can be represented by the appearance of
the supply or demand curve. A more elastic curve will be horizontal, and a less elastic curve
will tilt more vertically. When talking about elasticity, the term "flat" refers to curves that are
horizontal; a "flatter" elastic curve is closer to perfectly horizontal.

2.3.
Factors Influencing Elasticity of Demand
The elastic or inelastic nature of the demand for a commodity is determined by the following
factors:
a. Price of the commodity: The demand for a commodity rises when the price falls, and vice
versa with other factors affecting demand remaining constant. Thus, there exist inverse
relationship between price and quantity demanded.5
b. Income of the consumer: The effect of change in income of the consumer on the demand
will depend on the nature of the good.
In case of Normal good: When income increases demand increases. Thus, there is direct
relationship between income and demand.
In case of Inferior goods: When income increases demand increases upto a certain level
and then a high income level the demand decreases, that is, becomes an inferior good.
4 http://www.sparknotes.com/, accessed on oct 13th, 2015
5 Mittal, Abha., Micro Economics theory and applications, taxmann Publications (P.) Ltd, (2nd edition),
p.7

In case of Necessities: When income increases demand increases upto a certain income
level then remains unchanged as the income increases.6
c. Price of Related good: It shows the effect of the change in price of one commodity on the
demand of other commodity, also known as cross-price effect. The related good may be
Substitute goods and Complementary goods.7
d. Taste and Preferences: Greater the taste and preference for a commodity, greater is the
demand for the commodity. Thus, there exists direct relationship between taste and
preferences and demand for the commodity.
e. Future expectations: If the future expectation of the commodity is that its price will
decreases, then the demand of the commodity will automatically decreases. Whereas if
the expectation is for increasing its price then the demand will increase.
Since, taste & preferences and future expectations of the commodity can`t be quantified
in numbers. So these two factors remain outside the purview of measuring the elasticity
of demand. Although, there are many other factors like time, population etc., which are
active in influencing the elasticity of demand but since these factors can`t be quantified,
so they are included in the group of factors influencing elasticity but can`t be quantified.

CHAPTER-3
TYPES OF ELASTICITY OF DEMAND
Out of various determinants of demand, there are 3 quantifiers of demand i.e. Price of the
commodity, Price of related goods and Income of the consumer. Since Future expectation and
Taste and preferences of a consumer can`t be quantifiable so it remain out of the determinant
box of elasticity of demand.
So, we have 3 dimensions of Elasticity of demand:
1. Price elasticity of demand: It refers to the percentage change in demand for a commodity
with respect to percentage change in the price of given commodity.
2. Cross elasticity of demand: It refers to the percentage change in demand for a commodity
with respect to percentage in the price of the related goods (substitute goods or
complementary goods).
3. Income elasticity of demand: It refers to the percentage change in demand for a
commodity with respect to percentage in the income of the consumer.
6 Ibid, p.9
7 Ibid, p.7

3.1.

Price Elasticity of Demand

Price Elasticity of Demand means the degree of responsiveness of demand for a commodity
with reference to change in the price of such commodity. It establishes a quantitative
relationship between quantity demanded of a commodity and its price, while other factors
remain constant. Higher the numerical value of elasticity, larger is the effect of a price change
on the quantity demanded. For certain goods, a change in price leads to a greater change in
the demand, whereas, in some cases, there is a small change in demand due to change in
price. While finding the price elasticity of a commodity, price of related goods and income of
the consumer are assumed to remain constant.
For example, if prices of two commodities x and y rise by 10% and their demands fall by
20% and 5% respectively, then commodity x is said to be more elastic as compared to
commodity y.
Price is the most important factor of demand. So, price elasticity of demand is sometimes
shortened as Elasticity of Demand or Demand Elasticity or simply Elasticity. Unless
otherwise stated, whenever these words are used, they mean Price Elasticity of Demand.8
Price elasticity of demand (Ed) is thus given by:

3.1.1. Perfectly elastic demand: It refers to the situation where the slightest rise in price
causes the quantity demanded of a commodity to fall to zero and at the present level
of price people demand infinitely large quantity of the commodity. The coefficient of
elasticity of demand is infinite.

8 Ibid, p.4.3

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3.1.2. Perfectly inelastic demand: It refers to the situation where even substantial changes
in price do not make any change in the quantity demanded, i.e., for any change in the
price, the demand remains constant. The coefficient of elasticity of demand is zero.

3.1.3. Unitary Elastic: It refers to a situation where a given proportionate change in price is
accompanied by an equally proportionate change in the quantity demanded.

11

3.1.4. Highly Elastic: Here, a small proportionate change in the price of a commodity
results in a larger proportionate change in its quantity demanded. The coefficient of
elasticity of demand is greater than unity.

3.1.5. Less Elastic: A larger proportionate change in the price of a commodity results in a
smaller proportionate change in its quantity demanded. The coefficient of elasticity of
demand is greater than zero, but less than unity.

3.2.

Income Elasticity of Demand

The Income Elasticity of Demand, YED, is defined as

Income elasticity tells us how responsive quantity demanded is to a change in

income. But this time, everything except consumer incomes remains the same. In

12

particular, the price of the given good and also the prices of all related goods are
assumed to remain constant.9
3.2.1. Zero income elasticity: A given increase in the consumers money income does not
result in any increase in the quantity demanded of a commodity (Ei=0). See in fig (E)
given below.
3.2.2. Negative income elasticity: A given increase in the consumers money income is
followed by an actual fall in the quantity demanded of a commodity. This happens in
the case of economically inferior goods (Ei < 0). See in fig (D) given below.
3.2.3. Unitary income elasticity: A given proportionate rise in the consumers money
income is accompanied by an equally proportionate rise in the quantity demanded of
a commodity and vice versa (Ei=1). See in fig (C) given below.
3.2.4.

Income elasticity of demand greater than unity: For a given proportionate rise in
the consumers money income, there is a greater proportionate rise in the quantity
demanded of a commodity. Ei is greater than unity. This is in case of luxuries. See in
fig (A) given below.

3.2.5. Income elasticity of demand less than unity: For a given proportionate rise in the
consumers money income, there is a smaller proportionate rise in the quantity
demanded of a commodity. The income elasticity of demand is less than unity in case
of necessaries i.e., the percentage expenditure on necessaries increases in a smaller
proportion when the consumers money income goes up (Ei < 1). See in fig (B) given
below.

9 Maddala, G.S., Microeconomics: Theory and Applications, Tata McGraw-Hill, (2004), p.65

13

3.3.

Cross Elasticity of Demand

The cross elasticity of demand or cross-price elasticity of demand (XED) measures
the responsiveness of the demand for a good to a change in the price of another
good. It is measured as the percentage change in demand for the first good that
occurs in response to a percentage change in price of the second good

The cross elasticity of demand for substitute goods will always be positive, as shown
in figure given below, because the demand for one good will increase if the price for
the other good increases. For example, if the price of coffee increases (but
everything else stays the same), the quantity demanded for tea (a substitute
beverage) will increase as consumers switch to an alternative.
On the other hand, the coefficient for compliments will be negative, as shown in
figure given below. For example, if the price of coffee increases (but everything else

14

stays the same), the quantity demanded for coffee stir sticks will drop as consumers
will purchase fewer sticks. If the coefficient is 0, then the two goods are not related.10

10 http://www.investopedia.com/, accessed on oct 13th, 2015

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CHAPTER-4
USES OF ELASTICITY OF DEMAND
There are many uses of Elasticity of Demand in the market:1. International Trade: In order to fix prices of the goods to be exported, it is important to
have the knowledge about the elasticities of demand for such goods. A country may fix
higher prices for the products with inelastic demand. However, if demand for such goods
in the importing country is elastic, then the exporting country will have to fix lower
prices.11
2. Formulation of Governmental policies: The concept of price elasticity of demand is
important for formulating government policies, especially the taxation policy.
Government can impose higher taxes on goods with inelastic demand, whereas, low rates
of taxes are imposed on commodities with elastic demand.
3. Factor Pricing: Price elasticity of demand helps in determining price to be paid to the
factors of production. Share of each factor in the national product is determined in
proportion to its demand in the productive activity. If demand for a particular factor is
inelastic as compared to the other factors, then it will attract more rewards.
4. Decisions of Monopolist: A monopolist considers the nature of demand while fixing price
of his product. If demand for the product is elastic, then he will fix low price. However, if
demand is inelastic, then he is in a position to fix a high price.12
5. Paradox of poverty amidst plenty: a bumper crop, instead of bringing prosperity to
farmers, being poverty. This is called the paradox of poverty amidst plenty. It happens
due to inelastic demand for most of the agricultural products. When supply of crops
increases as a result of rich harvest, their prices drastically fall due to inelastic demand.
As a result, their total income goes down.13

11 Garg, Sandeep., Introductory Microeconomics, Dhanpat Rai Publications, (4 th revised edition, 2013),
p.4.14
12 Chatterjee, Ratna., An Introduction to Economics for pre-law students, Central Law Publications,
(2006), p.51

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CHAPTER-4
CONCLUSION
Elasticity measures the responsiveness of quantity to changes in some other variable. Price
elasticity of demand is defined as the ratio of percentage change in quantity demanded to
percentage change in price. Price is inversely proportional to the quantity demanded. Income
elasticity of demand is defined as the proportionate change in quantity demanded divided by
the proportionate change in income, with prices and tastes held constant. A normal good is
one for which the income elasticity is positive. An inferior good is one for which income
elasticity is negative. Cross elasticity of demand is defined as the proportionate change in
quantity demanded divided by the proportionate change in the price of a related good. A
substitute good is one for which the cross elasticity is positive. A complementary good is one
for which the cross elasticity is negative. It is also seen in this work that there is different
elasticity for different product depending upon its usefulness to a consumer. It also depends
upon the factors like price, income of the consumer, availability of relative goods, etc. the
concept of elasticity has been proved to be a very useful method in determining the taxation
policies of a country. It is largely used by the big companies in estimating their product sales,
in determining the price of its products and also by the government.

13 Garg, Sandeep., Introductory Microeconomics, Dhanpat Rai Publications, (4 th revised edition, 2013),
p.4.14

17

SELECT BIBLIOGRAPHY
Books
Garg, Sandeep., Introductory Microeconomics, Dhanpat Rai Publications, (4th revised
edition, 2013)
Chatterjee, Ratna., An Introduction to Economics for pre-law students, Central Law
Publications, (2006)
Maddala, G.S., Microeconomics: Theory and Applications, Tata McGraw-Hill, (2004)
Mittal, Abha., Micro Economics theory and applications, taxmann Publications (P.)
Ltd, (2nd edition)
Witztum, Amos. Economics: An Analytical Introduction, New York: Oxford
University Press, (2005)
Articles
Vzquez, Andrs. A New Approach To The Price Elasticity Of Demand, EGEA SPA,
Anno 52, No. 1/3 (Gennaio-Marzo 1993), accessed on August 5th, 2015, available in
Jstor.
Websites
http://www.investopedia.com/, accessed on October 13th, 2015
http://www.sparknotes.com/, accessed on October 13th, 2015