TYPES OF ELASTICITY OF DEMAND

Price elasticity of demand

PED is derived from the percentage change in quantity (%ΔQd) and

percentage change in price (%ΔP).

Price elasticity of demand (PED or Ed) is a measure used in economics to

show the responsiveness, or elasticity, of the quantity demanded of a good
or service to a change in its price. More precisely, it gives the percentage
change in quantity demanded in response to a one percent change in price
(holding constant all the other determinants of demand, such as income). It
was devised by Alfred Marshall.

Price elasticities are almost always negative, although analysts tend to

ignore the sign even though this can lead to ambiguity. Only goods which do
not conform to the law of demand, such as Veblen and Giffen goods, have a
positive PED. In general, the demand for a good is said to be inelastic (or
relatively inelastic) when the PED is less than one (in absolute value): that
is, changes in price have a relatively small effect on the quantity of the good
demanded. The demand for a good is said to be elastic (or relatively elastic)
when its PED is greater than one (in absolute value): that is, changes in
price have a relatively large effect on the quantity of a good demanded.

Revenue is maximised when price is set so that the PED is exactly one. The
PED of a good can also be used to predict the incidence (or "burden") of a
tax on that good. Various research methods are used to determine price
elasticity, including test markets, analysis of historical sales data and
conjoint analysis.

Definition
PED is a measure of the sensitivity (or responsiveness) of the quantity of a
good or service demanded to changes in its price.[1] The formula for the
coefficient of price elasticity of demand for a good is:

The above formula usually yields a negative value, due to the inverse nature
of the relationship between price and quantity demanded, as described by
the "law of demand".[3] For example, if the price increases by 5% and
quantity demanded decreases by 5%, then the elasticity at the initial price
and quantity = −5%/5% = −1. The only classes of goods which have a PED
of greater than 0 are Veblen and Giffen goods. Because the PED is negative
for the vast majority of goods and services, however, economists often refer
to price elasticity of demand as a positive value (i.e., in absolute value
terms).

This measure of elasticity is sometimes referred to as the own-price

elasticity of demand for a good, i.e., the elasticity of demand with respect to
the good's own price, in order to distinguish it from the elasticity of demand
for that good with respect to the change in the price of some other good,
i.e., a complementary or substitute good.[1] The latter type of elasticity
measure is called a cross-price elasticity of demand.

As the difference between the two prices or quantities increases, the

accuracy of the PED given by the formula above decreases for a combination
of two reasons. First, the PED for a good is not necessarily constant; as
explained below, PED can vary at different points along the demand curve,
due to its percentage nature.[8][9] Elasticity is not the same thing as the slope
of the demand curve, which is dependent on the units used for both price
and quantity.[10][11] Second, percentage changes are not symmetric; instead,
the percentage change between any two values depends on which one is
chosen as the starting value and which as the ending value. For example, if
quantity demanded increases from 10 units to 15 units, the percentage
change is 50%, i.e., (15 − 10) ÷ 10 (converted to a percentage). But if
quantity demanded decreases from 15 units to 10 units, the percentage
change is −33.3%, i.e., (15 − 10) ÷ 15.

Two alternative elasticity measures avoid or minimise these shortcomings of

the basic elasticity formula: point-price elasticity and arc elasticity.

Income elasticity of demand

In economics, income elasticity of demand measures the responsiveness
of the demand for a good to a change in the income of the people
demanding the good. It is calculated as the ratio of the percentage change in
demand to the percentage change in income. For example, if, in response to
a 10% increase in income, the demand for a good increased by 20%, the
income elasticity of demand would be 20%/10% = 2.

Interpretation

Inferior good's demand falls as consumer income increases.

A negative income elasticity of demand is associated with inferior goods; an

increase in income will lead to a fall in the demand and may lead to changes
to more luxurious substitutes.

A positive income elasticity of demand is associated with normal goods; an

increase in income will lead to a rise in demand. If income elasticity of
demand of a commodity is less than 1, it is a necessity good. If the elasticity
of demand is greater than 1, it is a luxury good or a superior good.

A zero income elasticity (or inelastic) demand occurs when an increase in

income is not associated with a change in the demand of a good. These
would be sticky goods.

Mathematical definition

More formally, the income elasticity of demand, , for a given Marshallian

demand function for a good is
or alternatively:

This can be rewritten in the form:

With income I, and vector of prices . Many necessities have an income

elasticity of demand between zero and one: expenditure on these goods may
increase with income, but not as fast as income does, so the proportion of
expenditure on these goods falls as income rises. This observation for food is
known as Engel's law.

Cross Elasticity of Demand

Here, a change in the price of one good causes a change in the demand for
another.

Cross elasticity of Demand

Proportionate change in purchases of commodity X
for X and Y = ---------------------------------------------------------------
Proportionate change in the price of commodity Y

This type of elasticity arises in the case of inter-related goods such as

substitutes and complementary goods.

The two commodities will be complementary, if a fall in the price of Y

increases the demand for X and conversely, if a rise in the price of one
commodity decreases the demand for the other. They will be substitute or
rival goods if a reduction in the price of Y decreases the demand for X, and
also if a rise in price of one commodity (say tea) increases the demand for
the other commodity (say coffee). The cross elasticity of complementary
goods is positive and that between substitutes, it is negative. It should,
however, be remembered that cross elasticity will indicate complementarities
or rivalry only if the commodities in question figure in the family budget in
small proportions.

Cross elasticity of demand can be used to indicate boundaries between

industries. Goods with high cross elasticity constitute one industry, whereas
goods with low cross elasticity constitute different industries. It is not to be
supposed that cross elasticity represents reciprocal relationship. It is not a
two-way street. The cross elasticity of a tea with respect to coffee is not
the same as that of coffee with respect to tea. The tastes of the consumer,
his money income and all prices except of the commodity Y are assumed to
remain constant.

Five cases of ED

Elastic- ( E>1 ) The demand for an item/good is strongly affected by the

change in price. This is where a change in a price causes a
proportionately smaller change in the quantity demanded. In this case
the value of elasticity will be greater than 1, since we are dividing larger
figure by smaller figure

Price

P1

P0

O Q1 Q0 Quantity

Inelastic- (E<1) This is where a change in a price causes a proportionately

smaller change in the quantity demanded. In this case elasticity will be less
than 1, since we are dividing a larger figure by a smaller figure. The demand for
an item is relatively unaffected by the change in price. For example, luxury
items on a gasoline.

Price

P1 20%
 P0
10%

0
q1 qo
Quantity

Unit elastic - Describes a demand curve which is perfectly responsive to

changes in price. That is, the quantity supplied or demanded changes
according to the same percentage as the change in price. A curve with an
elasticity of 1 is unit elastic. Not really any real life examples

Price

Po 20%

P1 20%

Qo Q1
Quantity

PERFECTLY INELASTIC: (E = ∞) An elasticity alternative in which infinitesimally small

changes in one variable (usually price) cause infinitely large changes in another variable (usually
quantity). Quantity is infinitely responsive to price. Any change in price, no matter how small,
triggers an infinite change in quantity. If the negative sign is not ignored, then the price elasticity
of demand is given by E = -∞.

Price

P1 10%

Po

O Qo

Quantity
Other Types of ED(PED, IED, CED)

Price elasticity of demand

PED is derived from the percentage change in quantity (%ΔQd) and

percentage change in price (%ΔP).

Price elasticity of demand (PED or Ed) is a measure used in economics to

show the responsiveness, or elasticity, of the quantity demanded of a good
or service to a change in its price. More precisely, it gives the percentage
change in quantity demanded in response to a one percent change in price
(holding constant all the other determinants of demand, such as income). It
was devised by Alfred Marshall.

Price elasticities are almost always negative, although analysts tend to

ignore the sign even though this can lead to ambiguity. Only goods which do
not conform to the law of demand, such as Veblen and Giffen goods, have a
positive PED. In general, the demand for a good is said to be inelastic (or
relatively inelastic) when the PED is less than one (in absolute value): that
is, changes in price have a relatively small effect on the quantity of the good
demanded. The demand for a good is said to be elastic (or relatively elastic)
when its PED is greater than one (in absolute value): that is, changes in
price have a relatively large effect on the quantity of a good demanded.

Revenue is maximised when price is set so that the PED is exactly one. The
PED of a good can also be used to predict the incidence (or "burden") of a
tax on that good. Various research methods are used to determine price
elasticity, including test markets, analysis of historical sales data and
conjoint analysis.

Definition
PED is a measure of the sensitivity (or responsiveness) of the quantity of a
good or service demanded to changes in its price.[1] The formula for the
coefficient of price elasticity of demand for a good is:

The above formula usually yields a negative value, due to the inverse nature
of the relationship between price and quantity demanded, as described by
the "law of demand".[3] For example, if the price increases by 5% and
quantity demanded decreases by 5%, then the elasticity at the initial price
and quantity = −5%/5% = −1. The only classes of goods which have a PED
of greater than 0 are Veblen and Giffen goods. Because the PED is negative
for the vast majority of goods and services, however, economists often refer
to price elasticity of demand as a positive value (i.e., in absolute value
terms).

This measure of elasticity is sometimes referred to as the own-price

elasticity of demand for a good, i.e., the elasticity of demand with respect to
the good's own price, in order to distinguish it from the elasticity of demand
for that good with respect to the change in the price of some other good,
i.e., a complementary or substitute good.[1] The latter type of elasticity
measure is called a cross-price elasticity of demand.

As the difference between the two prices or quantities increases, the

accuracy of the PED given by the formula above decreases for a combination
of two reasons. First, the PED for a good is not necessarily constant; as
explained below, PED can vary at different points along the demand curve,
due to its percentage nature.[8][9] Elasticity is not the same thing as the slope
of the demand curve, which is dependent on the units used for both price
and quantity.[10][11] Second, percentage changes are not symmetric; instead,
the percentage change between any two values depends on which one is
chosen as the starting value and which as the ending value. For example, if
quantity demanded increases from 10 units to 15 units, the percentage
change is 50%, i.e., (15 − 10) ÷ 10 (converted to a percentage). But if
quantity demanded decreases from 15 units to 10 units, the percentage
change is −33.3%, i.e., (15 − 10) ÷ 15.

Two alternative elasticity measures avoid or minimise these shortcomings of

the basic elasticity formula: point-price elasticity and arc elasticity.

Point-price elasticity

One way to avoid the accuracy problem described above is to minimize the
difference between the starting and ending prices and quantities. This is the
approach taken in the definition of point-price elasticity, which uses
differential calculus to calculate the elasticity for an infinitesimal change in
price and quantity at any given point on the demand curve:

In other words, it is equal to the absolute value of the first derivative of

quantity with respect to price (dQd/dP) multiplied by the point's price (P)
divided by its quantity (Qd).

In terms of partial-differential calculus, point-price elasticity of demand can

be defined as follows: let be the demand of goods as a
function of parameters price and wealth, and let be the demand for
good . The elasticity of demand for good with respect to price pk is

However, the point-price elasticity can be computed only if the formula for
the demand function, Qd = f(P), is known so its derivative with respect to
price, dQd / dP, can be determined.

Arc elasticity

A second solution to the asymmetry problem of having a PED dependent on

which of the two given points on a demand curve is chosen as the "original"
point and which as the "new" one is to compute the percentage change in P
and Q relative to the average of the two prices and the average of the two
quantities, rather than just the change relative to one point or the other.
Loosely speaking, this gives an "average" elasticity for the section of the
actual demand curve—i.e., the arc of the curve—between the two points. As
a result, this measure is known as the arc elasticity, in this case with respect
to the price of the good. The arc elasticity is defined mathematically as:

This method for computing the price elasticity is also known as the
"midpoints formula", because the average price and average quantity are
the coordinates of the midpoint of the straight line between the two given
points. However, because this formula implicitly assumes the section of the
demand curve between those points is linear, the greater the curvature of
the actual demand curve is over that range, the worse this approximation of
its elasticity will be.
Income elasticity of demand

In economics, income elasticity of demand measures the responsiveness

of the demand for a good to a change in the income of the people
demanding the good. It is calculated as the ratio of the percentage change in
demand to the percentage change in income. For example, if, in response to
a 10% increase in income, the demand for a good increased by 20%, the
income elasticity of demand would be 20%/10% = 2.

Interpretation

Inferior good's demand falls as consumer income increases.

A negative income elasticity of demand is associated with inferior goods; an

increase in income will lead to a fall in the demand and may lead to changes
to more luxurious substitutes.

A positive income elasticity of demand is associated with normal goods; an

increase in income will lead to a rise in demand. If income elasticity of
demand of a commodity is less than 1, it is a necessity good. If the elasticity
of demand is greater than 1, it is a luxury good or a superior good.

A zero income elasticity (or inelastic) demand occurs when an increase in

income is not associated with a change in the demand of a good. These
would be sticky goods.

Mathematical definition

More formally, the income elasticity of demand, , for a given Marshallian

demand function for a good is

or alternatively:
This can be rewritten in the form:

With income I, and vector of prices . Many necessities have an income

elasticity of demand between zero and one: expenditure on these goods may
increase with income, but not as fast as income does, so the proportion of
expenditure on these goods falls as income rises. This observation for food is
known as Engel's law.

Cross Elasticity of Demand

Here, a change in the price of one good causes a change in the demand for
another.

Cross elasticity of Demand

Proportionate change in purchases of commodity X
for X and Y = ---------------------------------------------------------------
Proportionate change in the price of commodity Y

This type of elasticity arises in the case of inter-related goods such as

substitutes and complementary goods.

The two commodities will be complementary, if a fall in the price of Y

increases the demand for X and conversely, if a rise in the price of one
commodity decreases the demand for the other. They will be substitute or
rival goods if a reduction in the price of Y decreases the demand for X, and
also if a rise in price of one commodity (say tea) increases the demand for
the other commodity (say coffee). The cross elasticity of complementary
goods is positive and that between substitutes, it is negative. It should,
however, be remembered that cross elasticity will indicate complementarities
or rivalry only if the commodities in question figure in the family budget in
small proportions.

Cross elasticity of demand can be used to indicate boundaries between

industries. Goods with high cross elasticity constitute one industry, whereas
goods with low cross elasticity constitute different industries. It is not to be
supposed that cross elasticity represents reciprocal relationship. It is not a
two-way street. The cross elasticity of a tea with respect to coffee is not
the same as that of coffee with respect to tea. The tastes of the consumer,
his money income and all prices except of the commodity Y are assumed to
remain constant.

Substitute good

A substitute good, in contrast to a complementary good, is a good with a positive cross

elasticity of demand.This means a good's demand is increased when the price of another
good is increased. Conversely, the demand for a good is decreased when the price of another
good is decreased. If goods A and B are substitutes, an increase in the price of A will result in a
leftward movement along the demand curve of A and cause the demand curve for B to shift
out. A decrease in the price of A will result in a rightward movement along the demand curve of
A and cause the demand curve for B to shift in.

Substitute goods exhibit a positive cross elasticity of demand: as the price of

good Y rises, the demand for good X rises

Examples

Classic examples of substitute goods include margarine and butter, or

petroleum and natural gas (used for heating or electricity). The fact that one
good is substitutable for another has immediate economic consequences:
insofar as one good can be substituted for another, the demand for the two
kinds of good will be bound together by the fact that customers can trade off
one good for the other if it becomes advantageous to do so.

Increase in price

An increase in price (ceteris paribus) will result in an increase in demand for

its substitutes goods. Thus, economists can predict that a spike in the cost of
wood will likely mean increased business for bricklayers, or that falling
cellular phone rates will mean a fall-off in business for public pay phones.
Different types

It is important to note that when speaking about substitute goods we are

speaking about two different kinds of goods; so the "substitutability" of one
good for another is always a matter of degree. One good is a perfect
substitute for another only if it can be used in exactly the same way. In
that case the utility of a combination is an increasing function of the sum of
the two amounts, and theoretically, in the case of a price difference, there
would be no demand for the more expensive good.

In microeconomics, two types of substitutes are being distinguished. Good X

is said to be gross substitute of good Y if

Goods X and Y are said to be net substitutes if

where U = U(X,Y) is a utility function.

Perfect and Imperfect substitutes

Indifference curve for perfect substitutes

Perfect substitutes may alternatively be characterized as goods having a
constant marginal rate of substitution. Alternative types of soft drinks are
commonly used as an example of perfect substitutes. As the price of Coca
Cola rises, consumers would be expected to substitute Pepsi in equal
quantities, i.e., total cola consumption would hold constant. Also, blank
media such as a writable Compact Discs from alternate manufacturers would
be perfect substitutes. If one manufacturer raises the price of its CDs,
consumers would be expected to switch to a lower cost manufacturer.

Imperfect substitutes exhibit variable marginal rates of substitution along

the consumer indifference curve.

Perfect Competition

One of the requirements for perfect competition is that the products of

competing firms should be perfect substitutes. When this condition is not
satisfied, the market is characterized by product differentiation.

Good Substitution

Substitute goods exhibit no complementarities, as in a complementary good.

In other words, good substitution is an economic concept where two goods

are of comparable value. Potatoes from different farms are an example; if
the price one farm's potatoes goes up, people will stop buying them and buy
the other farm's instead, ceteris paribus (assuming that potatoes from
different farms are ho

Complementary good

Complementary goods exhibit a negative cross elasticity of demand: as the price of

good Y rises, the demand for good X falls.
A complementary good, in contrast to a substitute good, is a good with a
negative cross elasticity of demand.[1] This means a good's demand is increased
when the price of another good is decreased. Conversely, the demand for a good is
decreased when the price of another good is increased.[2] If goods A and B are
complements, an increase in the price of A will result in a leftward movement along
the demand curve of A and cause the demand curve for B to shift in; less of each
good will be demanded. A decrease in price of A will result in a rightward movement
along the demand curve of A and cause the demand curve B to shift outward; more
of each good will be demanded.

Example

Supply and demand of hotdogs

An example of this would be the demand for hotdogs and hotdog buns. The supply
and demand of hotdogs is represented by the figure at the right with the initial
demand D1. Suppose that the initial price of hotdogs is represented by P1 with a
quantity demanded of Q1. If the price of hotdog buns were to decrease by some
amount, this would result in a higher quantity of hotdogs demanded. This higher
quantity demanded would cause the demand curve to shift outward to a new
position D2. Assuming a constant supply S of hotdogs, the new quantity demanded
will be at D2 with a new price P2.

Other examples include:

• Peanut butter and jelly

• Printers and ink cartridges
• DVD players and DVDs
• Computer hardware and computer software

Perfect complement
Indifference curve for perfect complements

A perfect complement is a good that has to be consumed with another

good. The indifference curve of a perfect complement will exhibit a right
angle, as illustrated by the figure at the right.[3] Few goods in the real world
will behave as perfect complements.[4] One example is a left shoe and a
right; shoes are naturally sold in pairs, and the ratio between sales of left
and right shoes will never shift noticeably from 1:1 - even if, for example,
someone is missing a leg and buys just one shoe.

The degree of complementarity, however, does not have to be mutual; it can

be measured by cross price elasticity of demand. In the case of video
games, a specific video game (the complement good) has to be consumed
with a video game console (the base good). It does not work the other way:
a video game console does not have to be consumed with that game.

Luxury good

In economics, a luxury good is a good for which demand increases more

than proportionally as income rises, in contrast to a "necessity good", for
which demand is not related to income.

Luxury goods are said to have high income elasticity of demand: as

people become wealthier, they will buy more and more of the luxury
good. This also means, however, that should there be a decline in income
its demand will drop. Income elasticity of demand is not constant with
respect to income, and may change sign at different levels of income.
That is to say, a luxury good may become a normal good or even an
inferior good at different income levels, e.g. a wealthy person stops
buying increasing numbers of luxury cars for his automobile collection to
start collecting airplanes (at such an income level, the luxury car would
become an inferior good)

The Mercedes-Benz S-class is an example of a luxury good.

Defining luxury
The concept of luxury has been present in various forms since the beginning
of civilization. Its role was just as important in ancient western and eastern
empires as it is in modern societies.[1] With the clear differences between
social classes in earlier civilizations, the consumption of luxury was limited to
the elite classes. It also meant the definition of luxury was fairly clear.
Whatever the poor cannot have and the elite can was identified as luxury.
With increasing ‘democratization’, several new product categories were
created within the luxury markets which were aptly called – accessible
luxury or mass luxury. This kind of luxury specifically targeted the middle
class (or what is sometimes termed as aspiring class). As luxury penetrated
into the masses, defining luxury has become ever so difficult.

In contemporary marketing usage, Prof. Bernard Dubois defines ‘luxury’ as a

specific (i.e. higher-priced) tier of offer in almost any product or service
category. However, despite the substantial body of knowledge accumulated
during the past decades, researchers still haven’t arrived on a common
definition of luxury. Many other attempts have been made to define luxury
using the price-quality dimension stating higher priced products in any
category is luxury. Similarly, researchers have used the uniqueness aspects
of luxury too. Prof. Jean-Noel Kapferer, takes an experiential approach and
defines luxury as items which provide extra pleasure by flattering all senses
at once. Several other researchers focus on exclusivity dimension and argue
that luxury evokes a sense of belonging to a certain elite group.

Socioeconomic significance

18 or more karat gold jewelry is an example of a luxury good.

Several manufactured products attain the status of "luxury goods" due to

their design, quality, durability or performance that are remarkably superior
to the comparable substitutes. Thus, virtually every category of goods
available on the market today includes a subset of similar products whose
"luxury" is marked by better-quality components and materials, solid
construction, stylish appearance, increased durability, better performance,
advanced features, and so on. As such, these luxury goods may retain or
improve the basic functionality for which all items of a given category are
originally designed.
There are also goods that are perceived as luxurious by the public simply
because they play a role of status symbols as such goods tend to signify the
purchasing power of those who acquire them. These items, while not
necessarily being better (in quality, performance, or appearance) than their
less expensive substitutes, are purchased with the main purpose of
displaying wealth or income of their owners. These kinds of goods are the
objects of a socio-economic phenomenon called conspicuous consumption
and commonly include luxury vehicles, expensive watches and jewelry,
designer clothing, yachts, and large residences, urban mansions and country
houses.

Normal good

In economics, normal goods are any goods for which demand increases
when income increases and falls when income decreases but price remains
constant, i.e. with a positive income elasticity of demand.[1][2] The term does
not necessarily refer to the quality of the good.

Depending on the indifference curves, the amount of a good bought can

either increase, decrease, or stay the same when income increases. In the
diagram below, good Y is a normal good since the amount purchased
increases from Y1 to Y2 as the budget constraint shifts from BC1 to the
higher income BC2. Good X is an inferior good since the amount bought
decreases from X1 to X2 as income increases.

Inferior good

In consumer theory, an inferior good is a good that decreases in demand

when consumer income rises, unlike normal goods, for which the opposite is
observed. Normal goods are those for which consumers' demand increases
when their income increases. [2] Inferiority, in this sense, is an observable
fact relating to affordability rather than a statement about the quality of the
good. As a rule, too much of a good thing is easily achieved with such goods,
and as more costly substitutes that offer more pleasure or at least variety
become available, the use of the inferior goods diminishes.

Good Y is a normal good since the amount purchased increases from Y1 to

Y2 as the budget constraint shifts from BC1 to the higher income BC2. Good
X is an inferior good since the amount bought decreases from X1 to X2 as
income increases.

Depending on consumer or market indifference curves, the amount of a

good bought can either increase, decrease, or stay the same when income
increases.

Examples

• Tahitian Treat: A low-cost carbonated fruit punch beverage.

• Thirst Rockers: A Kroger brand of imitation juice beverage in gallon
milk jugs.
• "Valu-Time" Ice Cream: Ice cream sold in 2.5 gallon plastic pails at
grocery stores, with an emphasis on value and quantity as opposed to
quality or advertising.
• Cosmic brownies: Low cost cakes resembling small brownies
manufactured by the Little Debbies company.
• Faygo Brand soda: A low cost non-advertised soda pop manufactured
in Detroit, MI.