What is Elastic Demand?
Elastic demand is an economic concept in which the demand for the product is highly sensitive and inversely proportional to the price of the product. For example, when the price of a particular good falls, consumers tend to buy at the higher quantity and vice versa. This means the demand for that particular good is price sensitive in nature.
Elastic Demand Formula
Let’s say,
- Initial quantity = Q1
- Final Quantity =Q2
- Initial Price = P1
- Final Price = P2
Formula = ((Q2-Q1)/(Q1+Q2))/((P2-P1)/(P1+P2))
If it is more than one, then it is a product is having an elastic demand.
Elastic Demand Examples with Curve
The elasticity of demand curve shows the degree of responsiveness or sensitivities of the quantity that is demanded of a product or of a commodity majority due to changes in the price of that product or commodity, keeping other things as constant or in other words remaining the same ( ceteris paribus ). Let us look at the following situations –
Example #1
Aswath Singh is a newly hired economist at State economist ltd. He has been given to work upon a small project on the elasticity of demand and he is asked to identify the situation where irrespective of price change, the demand remains the same.
Solution:
Mr. Singh while doing research at the topic observed that this would be a situation that is called zero elasticity. In this case, the demand would remain constant irrespective of whatever the price be. The below diagram depicts that.
We have a price on Y-axis and quantity demanded on the x-axis where we can see that quantity demanded remains the same irrespective of changes in price.
Hardly there are any practical live examples which will meet this situation. But, there are close examples which can be related to this like daily routine products which are consumed by people irrespective of price changes like salt which is used in daily life to prepare food. There are cases for some products where small changes in prices also don’t affect the quantity demanded but that won’t qualify here as for zero elasticity price can be anything.
Example #2
As per one survey, when the price of potato was 35 per kg the quantity demanded was 20,000 kgs and when the price of potato went up to 42 per kg the quantity demanded was 15,000. You are required to calculate price elasticity for potato, in this case, assuming all other things remaining constant and discuss the type of elasticity that is cited in this example.
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Solution:
The change in price in potato went up by 7 and hence the percentage change in price change of potato was 20%, whereas the quantity demanded decreased by 5,000 and here the percentage change in quantity demanded was -25%.
The formula for calculating demand elasticity is
Price elasticity = -25% / 20% = -0.50
Here, this situation is called elastic demand. This is the situation when the percentage change in quantity demand increases or decreases more than a percentage change in price decrease or increase. The real-life examples could be luxurious products like AC, TV, Smartphones. The graph for this type of elasticity would be steeper.
Example #3
Thomas cook the marketing head of Beauty soap limited wants to test the loyalty of their customers as they want to launch new products in shampoo and want to analyze whether the customer would opt for the same? He decides to first increase the price of the product for a few months and check the quantity demanded and after that decrease the price of the product for a few months and again check the quantity demanded.
After that test, the sales department reported the below numbers.
You are required to calculate price elasticity for a beauty soap, in this case, assuming all other things remaining constant and discuss the type of elasticity that is cited in this example.
Solution:
The change in price in beauty soap went up by 10 and hence the percentage change in price change of beauty soap was 11.11%, whereas the quantity demanded decreased by 2,000 and here the percentage change in quantity demanded was -2% for the 2nd quarter.
The formula for calculating demand elasticity is
Price elasticity = -2% / 11.11% = -0.18
The change in price in beauty soap went down by 5 in the 3rd quarter and hence the percentage change in price change of beauty soap was -5%, whereas the quantity demanded increased by 4,000 and here the percentage change in quantity demanded was 1.02% for the 1st quarter.
Price elasticity = 1.02% / -5% = -0.204
This situation is called as price inelastic, where the percentage change in quantity demanded increases or decreases lesser than the percentage change in price decreases or increases. The real-life examples could be toothpaste, rice, kerosene, etc. The above graph is steeper.
Example #4
The percentage change in ABC product rises by 20% when there is a fall in the price of the product by 20% and similarly when the price of the product rises by 20% the quantity demanded falls by the same proportion. You are required to discuss the type of elasticity referred to in this example.
Solution:
If we calculate the price elasticity here we will get the answer as 1. This is the case of unitary elastic, where the percentage change in quantity demanded is the same as the percentage change in price.
This kind of situation is imaginary and doesn’t exist in the real world.
Advantages of Elastic Demand
- Elastic demand helps to retain the price of the goods. If the demand is sensitive to the price, buyers would purchase their substitutes rather buying the primary product. Thus, it helps to maintain the price of the commodity.
- The availability of different substitutes helps to retain demand for all the varieties of goods.
- As per the law of demand, the price has a correlation with the quantity demanded. A slight increase in price would aid a slight decrease in the demand for the good. A further increase would result in a moderate fall in demand. However, a drastic increase or fall in price would inversely affect the quantity of the goods.
- Elastic demand justifies the demand-supply equilibrium in the economy.
Disadvantages of Elastic Demand
- The price increase of different goods results in a decrease in consumption. Thus, there would be a negative effect from the business point of view which leads to slash in overall income levels of the parties associated with the business. The labor or the staff related to the business would receive lower wages if the demand continues to shift downward.
- The demand for low pricing products gets higher. However, the margin remains low for the producer followed by the wage levels of the workers associated with the manufacturing of the goods and services. The only positive effect is the increment of the volume of the goods.
- Higher elasticity in demand due to the price changes lead to price fluctuation and the stability along with other economic factors erodes within the economy.
- During recession demand for basic commodities tend to be at high, for example, a consumer who uses premium clothing would choose basic clothing during hard times. Thus, demand elasticity is inversely proportionate with the price.
Limitations
- For most of the goods and services, there is an inverse correlation of demand with the price. But there are few luxury items that do not maintain the theory. Products like diamonds; some antique items always have their demand. In a few cases, the higher the price of the product leads to an increase in its demand.
- Commodities like salt, match-box does not follow the theory of ‘elastic demand’ as the prices of these goods are negligible compared to the income of the consumer. Thus an increase and decrease in the prices of these commodities do not change the demand for these items. Thus the theory of ‘Elastic Demand’ is not justified in case of the above items.
Conclusion
Elastic demand is an old phenomenon and is very much relevant in modern days. Depending upon the consumer needs, many business houses alter their strategy of doing business. In a recession, the production of luxury items gets slashed and basic commodities are taken produced more. Elastic demand helps to identify the opportunities and threats for individual and business firms.
Recommended Articles
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