What is Elastic Demand?
Elastic demand refers to an economic concept which states that the demand for a good or service changes with the fluctuations in its price. If a product has an elastic demand, it will have more buyers when its price goes down and vice-versa.
The concept helps measure the extent to which a product or service’s demand is affected by external factors. It helps in deciding product pricing, inventory planning, marketing strategies and expected returns.
Key Takeaways
- Elastic demand states that a commodity’s consumer demand spontaneously responds to its price change.
- The formula for the elasticity of demand = Percentage change in quantity/ Percentage change in demand.
- When elasticity is higher than 1, it signifies products have an elastic demand. Such a demand curveDemand CurveDemand Curve is a graphical representation of the relationship between the prices of goods and demand quantity and is usually inversely proportionate. That means higher the price, lower the demand. It determines the law of demand i.e. as the price increases, demand decreases keeping all other things equal.read more is relatively flattened towards the x-axis, reflecting high sensitivity to change.
- Luxury products, consumer durables and those commodities which have many substitutes experience high demand elasticity.
- Other than price, other determinants affect the demand, such as consumer income, personal taste, substitute commodities, etc.
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Understanding Elastic Demand
Elastic demand reflects the change in a good or service’s demand against a determinant. The effect of price on demand is studied under the price elasticity of demand which relates to the law of demand. The law states that other factors being constant, a decrease in a good’s price will increase its demand and vice versa.
For example, luxury clothes have elastic demand under the price elasticity of demand. People usually rush to luxury brands when they announce discounts to buy more. But when we observe the reality, we realize that other factors such as consumer income, substitute goods, personal taste, etc., also affect the demand. A consumer could be addicted to a luxury brand of tea and buy it even after its price skyrockets.
To measure the reaction of demand, elasticity comes into the picture. The elasticity of demand measures the variability or extent to which the demand changes in response to a factor. The formula to measure if the demand is elastic or not is explained below.
Elastic Demand Formula
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To find out if a product has elastic demand, we will need to apply the elasticity of demand formula. The formula for the elasticity of demand is as follows
Elasticity of Demand or Ed = Percentage change in quantity/ Percentage change in price
Percentage change in quantity = Change in Quantity/ Average Quantity
Change in quantity can be found by deducting old quantity from new quantity.
Percentage change in price = Change in Price/ Average Price
Change in price can be found by deducting old price from new price.
When we apply this formula, and the outcome is more than 1, it becomes the case of elastic demand. In other words, whenever the elasticity of demand is more than 1, the demand will be sensitive to changes.
Elastic Demand Curve
The elasticity of demand is above one when there is high responsiveness to change against a determinant such as price. This will also be seen in the graph. Under the price elasticity of demand, the elastic demand graph will have price on the y-axis and quantity on the x-axis. The demand curve will be relatively flattened towards the x-axis, showing high sensitivity to price.
When the demand is not sensitive to price, it will result in inelastic demand. The demand for necessary goods such as milk, electricity, fuel, medicines will not go down with an increase in price as people will buy them largely no matter what. They are an example of inelastic goods and have less than 1 elasticity.
Additionally, a product will have unitary elasticity if its demand varies in exact proportion to the percentage change in its price. Here, elasticity of demand is one.
Finally, under the definition of perfectly elastic demand, the results will change. The change in a commodity’s price will result in an infinite change in its demand. As such, if the price goes down, the demand will rise to infinity and vice-versa. Here the demand curve will be parallel to the x-axis.
Examples of Elastic Demand with Calculations
To better understand this concept, let’s take you through the following two examples:
Case 1
ABC Electronics initially sold 1500 LED televisions a year at $1000 per TV. The price of LED TV reduced to $900, and the demand increased to 1800 units. Find the elasticity of demand.
Percentage change in demand =
(1800-1500) / (1500+1800/2)
= 0.125
Percentage change in price = (900-1000) / (1000+900/2)
=0.10 (ignore the – sign)
Elasticity of Demand or Ed =0.125/0.10
Ed=1.25
Hence, the company experienced elastic demand since Ed˃1, signifying the change in demand is higher than the change in the price of LED TVs.
Case 2
XYZ Beverages Ltd. produces coffee. The initial price of coffee was $80 per kg, and the quantity demandedQuantity DemandedQuantity demanded is the quantity of a particular commodity at a particular price. It changes with change in price and does not rely on market equilibrium.read more per month was 1200 kgs. The price rose to $100 per kg, but the quantity demanded decreased to 1150kgs. Find the elasticity of demand.
Percentage change in demand =
(1150-1200) / (1200+1150/ 2)
= 0.02
Percentage change in price =
(100-80) / (80+100) /2)
= 0.11 (ignore the – sign)
Ed = 0.02/0.11
Ed = 0.18
Since, Ed˂1, the change in demand is not that significant to the change in the price of coffee.
Other Determinants of Elasticity
Except for or along with price, various other factors contribute to the change in demand for goods or services. The elasticity of demand is calculated for many of these factors too. These determinants are stated below:
- Consumer Income: A downfall in the consumers’ income results in decreased demand for a product or service. Say, John visited a cafe four times a month, but he restricted it to two due to a decline in his income.
- Substitute Goods: The commodities with substitutes experience volatile demand since the consumer can always switch to substitutesSubstitutesAny alternative, replacement, or backup of a primary product in the market is referred to as a substitute product. It refers to any commodity or combination of goods that might be used in place of a more popular item in normal circumstances without affecting the composition, appearance, or utility.read more if the product’s price increases. For instance, if butter’s price increases, many will shift to margarine to not affect their budget.
- Complementary Goods: If the price of a good rise, it will also affect the demand for its complementary. For example, if the price of vegetables becomes high, vegetarian food price will also go up in the restaurants. It will affect the demand of both.
- Necessity: Even when the price of necessary goods like flour or rice goes up, their demands do not vary much. On the other hand, if luxury products or services such as royal vacation packages rise in price, their demand falls.
- Time: Time is another essential factor; many times, a product’s demand doesn’t fall in the short run even after its price rise like iPhone’s paid applications. However, the customer can plan to change the mobile phone in the long run to avoid the high costs of such apps.
- Customer taste and preference: If consumers prefer a product, say a particular brand of clothing, they will keep buying it despite the price rise.
FAQs
A product whose demand among the consumers varies significantly with the variation in its price is termed elastic. On the contrary, a commodity whose price change hardly impacts its demand is known as inelastic.
Since in elastic demand, the price changes slightly, but the quantity demanded varies drastically. The demand curve here appears flatter and closer to the x-axis. As the demand elasticity increases, this curve flattens even more.
One of the best examples of elastic demand is the downfall in demand for gold jewellery when the gold price is high.
When we apply the formula for elasticity of demand which is – percentage change in quantity/ percentage change in demand, the result will help us understand if the demand is elastic or not. If the elasticity or outcome is more than 1, the demand is sensitive to change.
Salt is inelastic because even if its price goes high, its demand will not be much affected since it is an essential product.
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