1. Introduction: Why Do We Need to “Measure” Demand?
Suppose you are the manager of two stores: a Medical Store selling Salt/Medicines and an Electronics Store selling LED TVs.
- If you cut the price of Salt by 20%, will people start eating 20% more salt? No! Demand barely changes.
- If you cut the price of LED TVs by 20%, will sales jump? Yes — sales may jump by 50%!
Notice that the Law of Demand only tells us the direction (Price Down → Demand Up), whereas a manager needs to measure the exact responsiveness (magnitude). This measurement of responsiveness of demand is called Elasticity of Demand, a concept introduced by Dr. Alfred Marshall.
General Formula of Elasticity of Demand (Ed):
Elasticity of Demand (Ed) = (Percentage Change in Quantity Demanded) ÷ (Percentage Change in Determinant / Factor)
2. Four Major Types of Elasticity of Demand
1. Price Elasticity of Demand (Ep)
- Meaning: Measures the degree of responsiveness of quantity demanded of a commodity to a given percentage change in its own price.
- Formula:
Ep = (% Change in Quantity Demanded) ÷ (% Change in Price)
Ep = (ΔQ ÷ ΔP) × (P ÷ Q)
(Where Q = Initial Quantity, P = Initial Price, ΔQ = Change in Quantity, ΔP = Change in Price). - Simple Numerical Example: If the price of a T-shirt falls by 10% and its quantity demanded rises by 20%, then:
Ep = 20% ÷ 10% = 2 (Relatively Elastic Demand)
2. Income Elasticity of Demand (Ey)
- Meaning: Measures the responsiveness of quantity demanded to a given percentage change in the consumer’s income (Y).
- Formula:
Ey = (% Change in Quantity Demanded) ÷ (% Change in Consumer’s Income)
Ey = (ΔQ ÷ ΔY) × (Y ÷ Q) - Types of Income Elasticity:
- Positive Income Elasticity (Ey > 0): For Normal & Luxury Goods (as income rises, demand rises).
- Negative Income Elasticity (Ey < 0): For Inferior Goods (as income rises, demand for coarse grain/cheap goods falls).
- Zero Income Elasticity (Ey = 0): For Basic Necessities like Salt & Matchboxes (demand stays the same even when income rises).
3. Cross Elasticity of Demand (Ec)
- Meaning: Measures the responsiveness of demand for Good X to a percentage change in the price of Related Good Y.
- Formula:
Ec = (% Change in Quantity Demanded of Good X) ÷ (% Change in Price of Good Y)
- Types of Cross Elasticity:
- Positive Cross Elasticity (Ec > 0): For Substitute Goods (Tea & Coffee — when Coffee price rises, Tea demand rises).
- Negative Cross Elasticity (Ec < 0): For Complementary Goods (Car & Petrol — when Petrol price rises, Car demand falls).
- Zero Cross Elasticity (Ec = 0): For Unrelated Goods (Shoes & Mangoes).
4. Advertising (Promotional) Elasticity of Demand (Ea)
- Meaning: Measures the responsiveness of sales/demand to a given percentage change in advertising and promotional expenditure.
- Formula:
Ea = (% Change in Quantity Demanded / Sales) ÷ (% Change in Advertising Expenditure)
3. The 5 Degrees (Types) of Price Elasticity of Demand
Depending on how strongly buyers react to a price change, Price Elasticity of Demand (Ep) has 5 degrees ranging from Zero (0) to Infinity (∞):
| # | Degree of Price Elasticity | Numerical Value | Meaning & Consumer Reaction | Shape of Demand Curve | Real-Life Example |
|---|---|---|---|---|---|
| 1 | Perfectly Elastic Demand | Ep = ∞ (Infinity) | Even a tiny rise in price reduces demand to zero, while at the current price buyers will buy any amount. | Horizontal straight line parallel to X-axis. | Imaginary textbook case (a single farmer selling wheat under pure competition). |
| 2 | Perfectly Inelastic Demand | Ep = 0 (Zero) | A rise or fall in price causes NO change (0% change) in quantity demanded! | Vertical straight line parallel to Y-axis. | Life-saving drugs (Insulin), Salt. |
| 3 | Unitary Elastic Demand | Ep = 1 | % Change in Quantity Demanded = % Change in Price (e.g., 10% price fall → exact 10% demand rise). | Rectangular Hyperbola curve. | Standard household comforts (Ceiling fans, normal clothes). |
| 4 | Relatively Elastic Demand (More than Unitary) | Ep > 1 (between 1 and ∞) | % Change in Quantity Demanded > % Change in Price (e.g., 10% price cut → 25% jump in sales!). | Flatter downward-sloping curve. | Luxury Goods & Goods with Close Substitutes (ACs, Cars, Pepsi, Restaurant dining). |
| 5 | Relatively Inelastic Demand (Less than Unitary) | Ep < 1 (between 0 and 1) | % Change in Quantity Demanded < % Change in Price (e.g., 20% price rise → only 5% fall in demand). | Steeper downward-sloping curve. | Essential Necessities (Wheat, Rice, Milk, Petrol, Electricity). |
4. Methods of Measuring Price Elasticity of Demand
In your DAVV exam, write these 4 standard methods of measuring Price Elasticity of Demand:
Method 1: Percentage / Proportionate Method (Flux’s Method)
- Compares the percentage change in quantity demanded with the percentage change in price:
Ep = (% Change in Quantity Demanded) ÷ (% Change in Price)
Ep = (ΔQ ÷ Q) ÷ (ΔP ÷ P) = (ΔQ ÷ ΔP) × (P ÷ Q)
Method 2: Total Outlay / Total Expenditure Method (Alfred Marshall’s Method)
- Instead of calculating percentages, Dr. Alfred Marshall measured elasticity by observing how Total Expenditure (Total Outlay = Price × Quantity) changes when Price changes!
| Case | When Price Falls (⬇) | When Price Rises (⬆) | Degree of Elasticity |
|---|---|---|---|
| 1. Elastic Demand (Ep > 1) | Total Expenditure RISES (⬆) (Opposite direction to price) | Total Expenditure FALLS (⬇) (Opposite direction to price) | Ep > 1 (Greater than Unitary) |
| 2. Unitary Elastic (Ep = 1) | Total Expenditure REMAINS CONSTANT (No change) | Total Expenditure REMAINS CONSTANT (No change) | Ep = 1 (Unitary Elastic) |
| 3. Inelastic Demand (Ep < 1) | Total Expenditure FALLS (⬇) (Same direction as price) | Total Expenditure RISES (⬆) (Same direction as price) | Ep < 1 (Less than Unitary) |
- Quick Example: At Price ₹10, people buy 100 units (Total Expenditure = ₹1,000). When Price falls to ₹8, if people buy 150 units (Total Expenditure rises to ₹1,200), then Ep > 1 (Elastic)!
Method 3: Point / Geometric Method (For a Small Change on a Straight-Line Demand Curve)
- Used to measure elasticity at a specific point on a straight-line demand curve touching both axes:
Ep at Point P = (Lower Segment of Demand Curve below Point P) ÷ (Upper Segment of Demand Curve above Point P)
- At the exact Mid-Point of a straight-line demand curve: Lower Segment = Upper Segment, so Ep = 1!
- At the Y-axis touchpoint: Upper segment is 0, so Ep = ∞.
- At the X-axis touchpoint: Lower segment is 0, so Ep = 0.
Method 4: Arc Elasticity Method (For Large Changes Between Two Points)
- When the price change is large, using initial price (P1) vs. new price (P2) gives two different answers! To fix this, the Arc Method uses the average (mid-point) of both prices and both quantities:
Ep = ((Q2 − Q1) ÷ (P2 − P1)) × ((P1 + P2) ÷ (Q1 + Q2))
💡 DAVV Exam Tip
Question (10 Marks): “What is Elasticity of Demand? Explain the five degrees of Price Elasticity of Demand and the methods of measuring it.”
- Draw the 5-Row Table of Degrees of Price Elasticity (
Ep = ∞, Ep = 0, Ep = 1, Ep > 1, Ep < 1).- Under Methods, explain all 4 Methods (1. Percentage Method, 2. Marshall’s Total Outlay Method, 3. Point Method = Lower Segment ÷ Upper Segment, 4. Arc Method) with their formulas!