Laws of Demand, Elasticity of Demand & Types
Elasticity of Demand
Definition: Elasticity of demand measures the responsiveness or sensitivity of the quantity demanded of a good to changes in other economic variables such as price or income. It helps understand how changes in these variables affect demand.
Formula: Elasticity of Demand=% Change in Quantity Demanded% Change in Economic Variable\text{Elasticity of Demand} = \frac{\% \text{ Change in Quantity Demanded}}{\% \text{ Change in Economic Variable}}Elasticity of Demand=% Change in Economic Variable% Change in Quantity Demanded
A higher elasticity value indicates greater sensitivity of demand to changes in the economic variable.
Types of Demand Elasticity
- Price Elasticity of Demand:
- Definition: Measures the responsiveness of the quantity demanded of a good to a change in its price.
- Formula: Price Elasticity of Demand=% Change in Quantity Demanded% Change in Price\{Price Elasticity of Demand} = \frac{\% \{ Change in Quantity Demanded}}{\% \{ Change in Price}}Price Elasticity of Demand=% Change in Price% Change in Quantity Demanded
- Application: Helps companies understand how changes in price affect demand, aiding in pricing strategy to maximize profits.
- Income Elasticity of Demand:
- Definition: Measures the responsiveness of demand for a product to changes in consumer income.
- Formula: Income Elasticity of Demand=% Change in Quantity Demanded% Change in Income\text{Income Elasticity of Demand} = \frac{\% \{ Change in Quantity Demanded}}{\% \{ Change in Income}}Income Elasticity of Demand=% Change in Income% Change in Quantity Demanded
- Application: Helps predict changes in demand as consumer incomes change, useful for targeting marketing efforts and product positioning.
- Cross Elasticity of Demand:
- Definition: Measures the responsiveness of the quantity demanded for a good to a change in the price of another good.
- Formula: Cross Elasticity of Demand=% Change in Quantity Demanded of Good A% Change in Price of Good B\{Cross Elasticity of Demand} = \frac{\% \{ Change in Quantity Demanded of Good A}}{\% \{ Change in Price of Good B}}Cross Elasticity of Demand=% Change in Price of Good B% Change in Quantity Demanded of Good A
- Application: Indicates how the demand for one product is affected by the price change of another product, useful for understanding the relationship between complementary and substitute goods.
Interpretation of Elasticity
- Elastic Demand: Elasticity > 1
- Demand is responsive to changes in the economic variable.
- Inelastic Demand: Elasticity < 1
- Demand is not very responsive to changes in the economic variable.
- Unit Elastic Demand: Elasticity = 1
- Demand changes proportionately with the economic variable.
Law of Demand
Definition: The law of demand states that, ceteris paribus (all other factors being constant), the price and quantity demanded of a good are inversely related. As the price of a good increases, the quantity demanded decreases and vice versa.
Key Points:
- Inverse Relationship: Higher prices lead to lower quantity demanded; lower prices lead to higher quantity demanded.
- Demand Curve: A graphical representation showing the relationship between the price of a good and the quantity demanded.
- Demand Schedule: A table that shows the quantity demanded at different price levels.
Demand Schedule Example
Individual Demand Schedule for High-Quality Organic Bread
| Price per unit of bread (P) | Quantity demanded (Q) |
|---|---|
| $10 | 1,000 |
| $8 | 1,500 |
| $6 | 2,000 |
| $4 | 3,000 |
| $2 | 5,000 |
Market Demand Schedule Example
| Price per unit (P) | Quantity Demanded by Consumer A (QA) | Quantity Demanded by Consumer B (QB) | Market Demand (QA + QB) |
|---|---|---|---|
| $10 | 600 | 800 | 1,400 |
| $8 | 900 | 1,200 | 2,100 |
| $6 | 1,200 | 1,500 | 2,700 |
| $4 | 1,800 | 2,000 | 3,800 |
| $2 | 3,000 | 3,500 | 6,500 |
Graphical Representation
Demand Curve:
- Plots the quantity demanded (Q) on the X-axis and price (P) on the Y-axis.
- Slopes downward from left to right, illustrating the inverse relationship between price and quantity demanded.
Elasticity Graph:
- Elastic regions show significant changes in quantity demanded with price changes.
- Inelastic regions show minor changes in quantity demanded with price changes.
Practical Application
Understanding demand elasticity helps businesses and economists:
- Set optimal prices for goods and services.
- Predict consumer behavior in response to economic changes.
- Develop marketing and production strategies.
- Analyze the impact of policy changes on market demand.
By studying the elasticity of demand and the law of demand, businesses can make informed decisions to maximize profits and market efficiency.