What is elasticity of demand?elasticity of demand.

Overview

Demand
refers to that quantity of goods or services that people are willing to buy at a given
time. There a number of factors influencing this economic phenomenon. Key among these is
the price of the goods or services. When a commodity is highly priced, less people will
opt for it. On the other hand, a drop in price will lead to more of the same commodity
being purchased. Other factors that may influence demand are the tastes and preferences
of customers and the prices of substitute goods.

In this
regard, elasticity of demand is a measure of how quantities of goods demanded change
with slight movements in any of the factors mentioned
above.

Types of elasticity of
demand

i)
Price elasticity of
demand

This is the rate of change in
quantity of goods or services demanded due to subsequent change in price. It can be
expressed as a ratio or percentage by dividing the percentage change in quantity with
the percentage change in price.

Demand can be said to be
elastic when quantity change is more than subsequent price change. Unit elasticity is
attained when change in quantity equals change in price. Price reductions increases
expenditure while an increase lowers it. In unit elasticity the rise and fall in prices
has no effect on expenditure. If the change in quantities demanded is lower than changes
in price, this elasticity is referred to as
inelastic

ii)
Income elasticity of
demand

Income plays an important role in how
demand is influenced. When consumers experience changes in their levels of income, this
will definitely have an impact in demand. Income elasticity is the extent of change in
the quantity of a good demanded due to changes in a consumer’s income. Its formula is
change in the demand divided by the income change.

An
increase in the income of a consumer leads to an increase in demand. If the goods are
normal goods, elasticity is more than zero but below one, that is, tends to one. On the
other hand, inferior goods have an income elasticity of demand at anything below
1.

iii) Cross
Elasticity of demand

This type of elasticity
is related to substitute goods, in other words goods related to each other. For instance
coffee and tea are substitutes. Cross elasticity measures the way quantity of goods
demanded changes when there is a change in a substitute’s price. The formula is applied
by dividing the change in price of commodity X by change in price of commodity
Y.

Goods that are substitutes, like coffee and tea
influence each other’s demand such that when you increase the price of coffee, demand
for tea rises and vice versa.