Elasticity of demand: meaning, types and measurement

1. Meaning

The law of demand tells us the direction in which quantity changes when price changes. Elasticity of demand tells us by how much. Marshall defined it as the responsiveness of the quantity demanded to a change in price.

Price elasticity of demand:

e_p = percentage change in quantity demanded ÷ percentage change in price = (ΔQ / Q) ÷ (ΔP / P) = (ΔQ / ΔP) × (P / Q).

Because price and quantity move in opposite directions the result is negative; by convention the minus sign is dropped and the absolute value is used.

2. Types of elasticity of demand

• Price elasticity: response of demand to the good’s own price (the main subject of this note).
• Income elasticity = % change in quantity ÷ % change in income. Positive for normal goods; greater than one for luxuries (cars, air travel), between zero and one for necessities (salt, rice); negative for inferior goods (coarse grain).
• Cross elasticity = % change in quantity of X ÷ % change in price of Y. Positive for substitutes (tea and coffee), negative for complements (cars and petrol), zero for unrelated goods.
• Advertisement (promotional) elasticity: response of sales to a change in advertising outlay.

3. Degrees of price elasticity

Perfect elasticity is the demand curve facing a single firm under perfect competition. Perfect inelasticity is approached by life-saving drugs. Most luxuries are relatively elastic and most necessities relatively inelastic.

4. Methods of measurement

(a) Percentage (proportionate) method

Divide the percentage change in quantity by the percentage change in price. Price of a pen falls from Rs. 10 to Rs. 8 and quantity demanded rises from 100 to 150.

• % change in Q = 50 / 100 × 100 = 50%.
• % change in P = 2 / 10 × 100 = 20%.
• e_p = 50 / 20 = 2.5: relatively elastic.

(b) Total outlay (total expenditure) method

Marshall’s method compares total spending (P × Q) before and after the price change.

The rule: if price and total outlay move in opposite directions, demand is elastic; if outlay is unchanged, unitary; if they move in the same direction, inelastic. The method shows only whether e is above, below or equal to one, not its exact value.

(c) Point (geometric) method

Used to measure elasticity at a point on a demand curve. For a straight-line demand curve meeting the price axis at A and the quantity axis at B, elasticity at any point R is:

e = lower segment (RB) ÷ upper segment (RA).

• At the midpoint, RB = RA, so e = 1.
• Above the midpoint, e > 1; at A (on the price axis) e = ∞.
• Below the midpoint, e < 1; at B (on the quantity axis) e = 0.

Example: a demand line 10 cm long; a point 6 cm from the quantity axis end and 4 cm from the price axis end has e = 6 / 4 = 1.5. For a curved demand curve, draw a tangent at the point and apply the same ratio to the tangent.

(d) Arc method

The percentage method gives a different answer depending on whether we start from the higher or the lower price. The arc method avoids this by using the averages of the two prices and the two quantities (the midpoint formula):

e = [ΔQ / (Q₁ + Q₂)/2] ÷ [ΔP / (P₁ + P₂)/2].

With the pen figures: ΔQ = 50, average Q = 125; ΔP = 2, average P = 9. e = (50 / 125) ÷ (2 / 9) = 0.4 × 4.5 = 1.8. Compare 2.5 by the percentage method starting from Rs. 10; starting from Rs. 8 the percentage method gives (50/150) ÷ (2/8) = 1.33. The arc figure lies between the two.

5. Determinants of elasticity

1. Nature of the good: necessities inelastic, luxuries elastic.
2. Availability of substitutes: many close substitutes make demand elastic (one brand of soap); none make it inelastic (salt).
3. Number of uses: a good with many uses (electricity) has more elastic demand.
4. Share of income spent: goods taking a tiny share (matches, salt) are inelastic.
5. Possibility of postponement: demand for goods whose purchase can be put off (a new car) is elastic.
6. Habit: tobacco and alcohol are inelastic for habitual users.
7. Time period: demand is more elastic in the long run, as consumers find substitutes.
8. Price level: very high and very low prices tend to inelastic demand.

6. Importance

• Pricing by firms and monopolists: a monopolist raises price where demand is inelastic and charges lower prices in elastic markets (price discrimination, Unit IV).
• Taxation: the finance minister collects more revenue by taxing goods with inelastic demand; the burden of such taxes falls largely on buyers.
• International trade: the gain from devaluation depends on the elasticity of demand for exports and imports.
• Paradox of poverty: a bumper harvest of a crop with inelastic demand lowers farmers’ total revenue, which is why support prices are needed.
• Wages: a trade union can raise wages more easily where demand for the product, and so for labour, is inelastic.

How this is examined

January 2026 set “Explain the methods of measuring price elasticity of demand” (16 marks, 100-mark paper) and “Define price elasticity of demand. Explain the types of price elasticity of demand” (10 marks, 80-mark paper). For the methods question, write all four methods, each with its formula and a short worked figure, and describe the point-method diagram. For the types question, define first, then give the five degrees with the curve shape, and finish with income and cross elasticity in a paragraph.