Elasticity of demand is an important variation on the concept of demand. Demand can be classified as elastic, inelastic or unitary.
An elastic demand is one in which the change in quantity demanded due to a change in price is large. An inelastic demand is one in which the change in quantity demanded due to a change in price is small.
The formula for computing elasticity of demand is:
(Q1 – Q2) / (Q1 +
Q2)
(P1 – P2) / (P1 + P2)
If the formula creates an absolute value greater than 1, the demand is elastic. In other words, quantity changes faster than price. If the value is less than 1, demand is inelastic. In other words, quantity changes slower than price. If the number is equal to 1, elasticity of demand is unitary. In other words, quantity changes at the same rate as price.
Elastic Demand
Elasticity of demand is illustrated in Figure 1. Note that a change in price results in a large change in quantity demanded. An example of products with an elastic demand is consumer durables. These are items that are purchased infrequently, like a washing machine or an automobile, and can be postponed if price rises. For example, automobile rebates have been very successful in increasing automobile sales by reducing price.
Close substitutes for a product affect the elasticity of demand. If another product can easily be substituted for your product, consumers will quickly switch to the other product if the price of your product rises or the price of the other product declines. For example, beef, pork and poultry are all meat products. The declining price of poultry in recent years has caused the consumption of poultry to increase, at the expense of beef and pork. So products with close substitutes tend to have elastic demand.
An example of computing elasticity of demand using the formula is shown in Example 1. When the price decreases from $10 per unit to $8 per unit, the quantity sold increases from 30 units to 50 units. The elasticity coefficient is 2.25.
Inelastic Demand
Inelastic demand is shown in Figure 2. Note that a change in price results in only a small change in quantity demanded. In other words, the quantity demanded is not very responsive to changes in price. Examples of this are necessities like food and fuel. Consumers will not reduce their food purchases if food prices rise, although there may be shifts in the types of food they purchase. Also, consumers will not greatly change their driving behavior if gasoline prices rise.
An example of computing inelasticity of demand using the formula above is shown in Example 2. When the price decreases from $12 to $6 (50%), the quantity of demand increases from 40 to only 50 (25%). The elasticity coefficient is .33.
This does not mean that the demand for an individual producer is inelastic. For example, a rise in the price of gasoline at all stations may not reduce gasoline sales significantly. However, a rise of an individual station’s price will significantly affect that station’s sales.
Unitary Elasticity
If the elasticity coefficient is equal to one, demand is unitarily elastic as shown in Figure 3. For example, a 10% quantity change divided by a 10% price change is one. This means that a 1% change in quantity occurs for every 1% change in price.
Don Hofstrand, retired extension value added agriculture specialist,
A product or service is said to have elastic demand when the change in quantity demanded is large when there is a change in price. Products and services have inelastic demand when the change in quantity demanded is small when there is a change in price. This is also known as "price inelasticity of demand."
Gasoline is an inelastic demand example, because the amount people buy remains roughly the same, even
when prices increase. Likewise, they don't buy much more even if the price drops. However, gas doesn't have a perfectly inelastic demand, where demand never changes regardless of price.
Note
There aren't many real-life examples of perfectly inelastic demand. If there were, then whoever was selling something with inelastic demand could charge any amount, and consumers would have to pay it.
How Does Inelastic Demand Work?
The Law of Demand says that the amount purchased should move inversely to price. That means that there should be a decrease in demand as prices increase, and an increase in demand as prices decrease. However, this relationship between price and demand isn't always perfectly correlated.
To calculate demand elasticity, you divide the percentage change in the quantity demanded for a good by the percentage change in the price for that same good. For instance, if the price of bananas were to drop by 10% with a corresponding demand-quantity increase of 10%, the ratio would be 0.1/0.1 = 1.
Note
The ratio of one is called "unit elastic," the term for when a change in quantity demanded is accompanied by an equal change in price.
Elastic demand occurs when the ratio of quantity demanded to price is more than one. For example, if the price dropped 10%, and the amount demanded rose 50%, the ratio would be 0.5/0.1 = 5. On the other end, if the price dropped 10%, and the quantity demanded didn't
change, the ratio would be 0/0.1 = 0. That is known as being "perfectly inelastic."
Examples of Inelastic Demand
Inelastic demand occurs when the ratio of quantity demanded to price is between zero and one unit elastic. This typically occurs when a particular good or service lacks adequate substitutes and represents a necessity.
Examples of
goods with inelastic demand include gasoline, necessary foods, and prescription drugs. When price changes on these items, demand doesn't fluctuate much because these items are required in the everyday lives of most consumers. In contrast, demand for luxury goods such as high-end cars, dessert foods, or entertainment tends to be much more elastic.
It's worth noting that demand may be inelastic for a broad category of goods—fruit, for example—but elastic for specific types or brands of that good. So, for instance, consumer demand for fruit may not fluctuate much, but a rise in apple prices might lead more people to buy grapes.
What Is the Inelastic Demand Curve?
You can tell whether the demand for an item is inelastic by looking at its demand curve. Since the quantity demanded doesn't change as much as the price, it will look steep. It will be any curve that is steeper than the unit elastic curve, which is a 45-degree angle as measured from the chart's horizontal axis.
Note
The more inelastic the demand, the steeper the curve. If it's perfectly inelastic, then it will be a vertical line.
Five factors determine the demand for an item. They are price, the price of alternatives, income, tastes, and expectations. For aggregate demand, the sixth determinant is the number of buyers. The demand curve shows how the quantity changes in response to price. If one of the other determinants changes, it will shift the entire demand curve. More or less of that good or service will be demanded, even though the price remains unchanged.
Inelastic Demand vs. Elastic Demand
| Low changes in demand with price changes. | High changes in demand with price changes. |
| Real-life examples include utilities, prescription drugs, or gas. | Real-life examples include luxury items or non-essential items. |
To clarify the difference between inelastic and elastic demand, it's important to know that "inelastic demand" is a term reserved for goods, services, or products that don't lose demand even if the price to buy them changes.
By contrast, elastic demand refers to products that fluctuate in consumer demand if their price changes. For example, if an item's price goes up, consumers likely won't buy as much. If the price goes down, they may end up buying more than predicted.
What Inelastic Demand Means for You
For consumers and businesses, the reality of inelastic demand means that some goods are more vulnerable to price swings than others. In many cases, these are the products that are most difficult to replace or forego.
When the price rises on a good with inelastic demand, you or your business may have to absorb this price change. To do this, you might have to purchase fewer luxury goods or items that aren't necessities. Conversely, when price drops on necessities, it may be wise for businesses to stock up to hedge against future price swings.
Key Takeaways
- Inelastic demand in economics occurs when the demand for a product doesn't change as much as the price.
- A steep demand curve graphically represents inelastic demand. The steeper the curve, the more inelastic the demand for that product or service is.
- Inelastic demand applies to products that are hardly responsive to price changes, such as gasoline or prescription drugs.
What is income elasticity of demand?
Income elasticity of demand measures how much the demand for specific goods and services fluctuates in relation to changes in consumer income. The effect will be similar, but the relationship works in the opposite direction of price elasticity. While rising prices usually result in lower demand, rising income tends to lead to higher demand. However, in both cases, demand for some goods is more elastic than it is for others.
What is cross-price elasticity of demand?
Cross-price elasticity refers to how much the price of one good fluctuates in response to price changes for another good. When one good can easily be substituted for another, there will usually be high cross-price demand elasticity between them. This is common, for example, with directly competing products such as similar cars from competing manufacturers or two similar smartphones.
What is the formula for calculating elasticity of demand?
Elasticity of demand = % change in demand for a good or service / % change in price for the same good or service