If the quantity demanded of a product changes greatly in response to changes in its price, it is elastic. That is, the demand point for the product is stretched far from its prior point. If the quantity purchased shows a small change after a change in its price, it is inelastic. Conversely it also means that a drop in price will result in higher demand.
Last month the company was able to sell 50,000 bottles of soft drinks at $1.50 per bottle. However, in the current month, the company has revised the price to $1.45 per bottle and expects to achieve month-end sales of 60,000. An example is if Pepsi increases the price of its beverage, customers may opt for other alternatives like Coca-Cola. Goods and services that can be substituted without difficulty have elastic demand.
Relatively elastic demand has a practical application as demand for many of products respond in the same manner with respect to change in their prices. The four main types of elasticity of demand are price elasticity of demand, cross elasticity of demand, income elasticity of demand, and advertising elasticity of demand. They are based on price changes of the product, price changes of a related good, income changes, and changes in promotional expenses, respectively. In 1998, 2,000 people in the United States died as a result of drivers running red lights at intersections. In an effort to reduce the number of drivers who make such choices, many areas have installed cameras at intersections. Drivers who run red lights have their pictures taken and receive citations in the mail.
The latter is when price changes do not significantly impact the demand. Often, necessities are inelastic while common goods and services are elastic. When the demand for a product is significantly impacted by changes in its prices, it is known as ‘elastic’.
The demand for a product can be elastic, inelastic, or unitary, depending on the rate of change in the demand with respect to the change in the price of a product. The income levels of consumers play an important role in the quantity demanded for a product. This can be understood by looking at the difference in goods sold in the rural markets versus the goods sold in metro cities. This measure of responsiveness of quantity demanded when there is a change in price is termed as the Price Elasticity of Demand (PED). Price elasticity of supply (PES) works in the same way that PED does.
The PED of the good is 0.4375, which is considered to be inelastic. Pete Rathburn is a copy editor and fact-checker with expertise in economics and personal finance and over twenty years of experience in the classroom. Paul Boyce is an economics editor with over 10 years experience in the industry. Currently working as a consultant within the financial services sector, Paul is the CEO and chief editor of BoyceWire. He has written publications for FEE, the Mises Institute, and many others. We can consider insurance as a prime example; at least specific types such as car and home insurance.
A good with perfectly elastic demand would have a PED of infinity, where even minuscule changes in price would cause an infinitesimally large change in demand. For suggestions on why these goods and services may have the elasticity shown, see the above section on determinants of price elasticity. The midpoint method is a commonly used technique to calculate the percent change of price. The primary difference is that it types of price elasticity of demand with examples calculates the percentage change of quantity demanded and the price change relative to their average. The law of demand states that an increase in price reduces the quantity demanded, and it is why demand curves are downwards sloping unless the good is a Giffen good. The arc method of measurement of price elasticity is to use the average of the original price and the changed price, origin demand and changed demand.
Let us understand perfectly inelastic demand with the help of an example. Therefore, in such a case, the demand for bread is perfectly elastic. Suppose product X is manufactured by a large number of sellers in the market.
It can be interpreted from Figure-3 that the movement in price from OP1 to OP2 and OP2 to OP3 does not show any change in the demand of a product (OQ). Perfectly inelastic demand is a theoretical concept and cannot be applied in a practical situation. However, in case of essential goods, such as salt, the demand does not change with change in price.
As you may have figured out, this is a number that you can only calculate for certain after you’ve made an actual price change and seen the resulting impact on demand. And to be truly certain, you’d have to change your price multiple times to see what would happen at each price point. Rather, they send out questionnaires, run focus groups, or perform small-scale experiments in certain markets, to give them a sense of what would happen if they changed their price.
Unlike the aforementioned types of demand, relatively elastic demand has a practical application as many goods respond in the same manner when there is a price change. On the basis of the amount of fluctuation shown in the quantity demanded of a good, it is termed as ‘elastic’, ‘inelastic’, and ‘unitary’. Among the most common applications of price elasticity is to determine prices that maximize revenue or profit. At an elasticity of 0 consumption would not change at all, in spite of any price increases. If the income elasticity of demand is higher than 1, then the good is considered to be income elastic – implying that demand rises faster than income. In the long term, consumers are more elastic over longer periods, as over the long term after a price increase of a good, they will find acceptable and less costly substitutes.
With price inelastic (as opposed to perfectly inelastic) demand, the demand curve itself is still downward sloping. In our first example, an increase in price increased total revenue. Is there a way to predict how a price change will affect total revenue? To determine how a price change will affect total revenue, economists place price elasticities of demand in three categories, based on their absolute value. If the absolute value of the price elasticity of demand is greater than 1, demand is termed price elastic.
To call demand curve as elastic or inelastic is altogether wrong. Elasticity of demand is shown by a point on demand curve at different points and, therefore, they have different elasticities. But it’s not just about figuring out the right number; you need to understand consumer behavior as well. “You could run market tests every day,” says Avery, “but you also want to understand why consumers are acting the way they are. Understanding the why behind consumer behavior is critical to predicting how they will respond in the future.” That information will inform your marketing efforts.
Increased prices will reduce demand significantly, and decreased prices will spur demand. The factors listed below contribute to demand being elastic, especially when two or more are at play. We can further classify these elastic and inelastic types of demand into five categories.
Elasticity of Demand can be measured from the changes in the expenditure of consumers as price changes. Marshall was the major proponent of this method and he called it the Total Expenditure Method and Outlay Method. The greater the number of uses the higher the price elasticity of demand and vice-versa.