The concept of price elasticity of demand can be used to divide the good into three groups:
- Elastic: when the percent change in quantity of a good than the percent change in its price, the demand is said to be elastic. When elasticity of demand is greater than one then it is term as elastic.
Mathematically: %Qd=%P and Ed>1
- ii. Unitary elasticity:when the percentage change in the quantity demanded is equal to percentage change in its price, the price elasticity of demand is said to have unitary elastic. When elasticity of demand is equal to one then it is termed as unitary elastic.
Mathematically: %Qd=%P and Ed=1
iii. Inelastic: when the percent change in quantity demanded of a good is less than the percentage change in its price, the demand is called inelastic. When elasticity of demand is less than one than one then it is termed as inelastic.
Mathematically: %Qd<%P and Ed<1
- Income elasticity of Demand:
Definition and explanation:
Income is an important variable affecting the demand for a good. When there is a change in the level of income of a consumer,
There is a change is a quantity demanded of a good, other factors remaining the same. The degree of change or responsiveness of quantity demanded of a good to a change in the income of a consumer is called income elasticity of demanded. Income elasticity of demanded can be defined as;
“The ratio of percentage change in the quantity of a good purchased, per unit of time to a percentage change in the income of a consumer”.
The formula for measuring the income elasticity of demand is the percentage change in demand for a good divided by the percentage change in income. Putting this in symbol gives.
A simple will example will show how income elasticity of demand can be calculated. Let us assume that the income of a person is TK. 4000 per month and he purchases six CD’s per month. Let us assume that the monthly income of the consumer increase to Tk. 600 and the quantity demanded of Cd’s per month rises to eight. The elasticity of demand for CD’s will be calculated as under:
Q = 8-6=2
Y= TK.6000-TK. 4000 =TK. 2000
Original quantity demanded=6
Original income + TK= 4000
= Q/∆YY/Q= 2/ 20004000/ 6 = 0.66
The income elasticity is 0.66 which is less than one.
Types of income elasticity:
When the income of person increases, his demand for goods also change depending upon the factors, whether the good is a normal good or an inferior good.
(i) Normal goods: When the value of elasticity is greater than zero but less than one.
(ii) Inferior goods: Goods with an income elasticity of less than 1 are called inferior goods.
For example, people buy more food as their income rises but the percent increase in its demand is less than the percent increases in income.
(3) Cross Elasticity of Demand:
Definition and Explanation:
The concept of cross elasticity of demand is used for measuring the responsiveness of quantity demanded of a good to changes in the price of related goods. Cross elasticity of demand is defined as;
“The percentage change in the demand of one good as a result of the percentage change in the price of another goods”.
The formula for measuring, cross elasticity of demand is:
The numerical value of cross elasticity depends on whether the two goods in question are substitutes, complements or unrelated.
Types and example:
- Substitute Goods: When two goods are substitute of each other, such as coco-cola and Pepsi, an increase in the price of one good will lead to an increase in demand for the other good. The numerical value of goods is positive.
For example there are two goods Coca-Cola and Pepsi which are close substitutes,. If there is increase in the price of Pepsi called good y by 10% and it increases the demand for Coca-Cola called good x by 5% the cross elasticity of demand would be.
Since is positive (E>0), Therefore,, Coca-Cola and Pepsi are close substitutes.
(ii)Complementary Goods: However, in case of complementary goods such as car and petrol, cricket bat and ball, a rise in the price of one good say cricket bat by 7% will bring a fall in the demand for the balls (say by 6%). The cross elasticity of demand which are complementary to each other is, therefore,, 6% / -75 =-0.85 (negative)
(iii) Unrelated Goods: The two goods which are unrelated to each other, say apples and pens, if the price of apple in the market, it is unlikely to result in a change in quantity demanded of pens. The elasticity is zero of unrelated goods.