What is Elastic Demand? Definition and Uses in Economics
By Indeed Editorial Team
Published 3 April 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Demand elasticity refers to the sensitivity of the requested quantity to variations in another external factor. Many types of elasticity of demand exist and one of the most relevant for companies is the price elasticity of demand. Whether you work in business, finance or economics, learning more about this concept can help you understand how price changes affect customers' demand. In this article, we answer the question, 'What is elastic demand?', discuss the various types and explain the uses of elastic demand.
What is elastic demand?
Learning the answer to the question 'What is elastic demand?' can make it easy to compare it with other forms of demand. Elastic demand is a concept in economics that arises when the quantity of a commodity responds intensively to a change in the price of the commodity. The formula for elastic demand is:
Elasticity = % Change in quantity / % Change in price
Types of elastic demand
Here are the various types of elastic demand:
Price elasticity of demand
Economists often use price elasticity of demand when measuring demand elasticity, as price is the most common economic factor used to measure demand. They plot demand curves on graphs with the price on the y-axis and quantity on the x-axis to show and determine the demand for a particular good or service. As a result, the curve is downward-sloping and an increase in price leads to a fall in demand.
Income elasticity of demand
Income elasticity of demand is a measure of how sensitive the quantity demanded for a certain good is to a change in real income, which is the personal income after inflation, of the consumers who buy it. The income level of consumers affects the quantity of a product purchased. For instance, the difference between goods sold in rural areas and those sold in metropolitan areas.
Cross elasticity of demand
Cross-price elasticity measures how sensitive the demand for a particular product is to changes in the corresponding price. This may lead to a positive or negative impact on the demand for another product in relation to a price change. Demand for substitute goods is always positive since demand increases when the price of the substitute good increases. Conversely, demand for complementary goods is always negative.
Zones of elasticity
Price elasticities for commodities differ depending on the item, and economists group these into different zones. Some commodities have a higher level of elastic demand, while others exhibit a higher level of relative elastic demand. The price elasticities of demand range from zero to infinite. Here are the zones of elasticity:
Perfectly elastic demand
Price changes produce very large changes in quantity demanded with very small price changes. This category is made up of basically pure commodities. In this case, there is no brand to consider, no product differentiation and customers have little or no attachment to the products.
Perfect elastic demand refers to the increase in quantity demanded to infinity when the price decreases and the decrease in quantity demanded to zero when the price increases.
Relatively elastic demand
Pricing is relatively elastic since small price changes can lead to large changes in demand. The numerical value of relatively elastic demand varies from one to infinity. For instance, an increase in price by 20% and a decrease in demand by 25% would be relatively elastic.
Unit elastic demand
A supply or demand curve that is unit elastic changes its quantity in proportion to changes in price. That is, a curve is a unit elastic if the elasticity is one. When selling goods with unit elastic demand, a company requires evaluating its pricing strategy carefully. This is because a substantial change in price changes the quantity demanded.
Relatively inelastic demand
In relatively inelastic demand, the proportionate change in quantity demanded for a product is always less than that in price. For instance, if we observe the price of petrol and compare its change in demand with the change in its price, there would not be much change in its demand in the current environment, despite the changes in price levels. The numerical value of relatively inelastic demand varies from zero to one.
Perfectly inelastic demand
Perfectly inelastic demand is a situation in which there is no change in quantity demanded regardless of price changes. It has a numerical value of zero. Perfectly inelastic demand cannot be applied to practice except in the case of essential goods.
Factors affecting elastic demand
Here are some factors that affect elastic demand:
Availability of substitutes
A readily available substitute for a good makes the demand for the good more elastic. If consumers substitute a good for another readily available good that they regard as similar, then the price elasticity of demand would be elastic. If consumers are unable to substitute a good, its price elasticity would be inelastic.
A good's price level can influence the demand elasticity of the good. Luxuries have a higher unitary elastic demand than necessities. In addition, the elasticity of demand is high at a higher price level and low at a lower price level.
The income level of a population may also influence the demand elasticity of goods and services. For instance, in the situation of an economic downturn, employers may lay off many employees. Where expenditure on a good represents a small proportion of consumer income, the price elasticity of demand tends to be low. That means that a change in the price of a good exerts little impact on the consumer's propensity to buy it.
A product that is produced by only one supplier generally has inelastic demand. A product that is produced in a competitive marketplace has elastic demand. This is because a competitive marketplace gives the consumer more choices.
Elastic demand vs. inelastic demand
The contrary to elastic demand is inelastic demand. When demand is elastic, it changes more than the price, and when it is inelastic, the price changes more than the demand. Demand is inelastic when consumers can tolerate more price fluctuations before they change their behaviour.
With elastic demand, the percentage change in a quantity of demand is greater than one with respect to the percentage change in price. In inelastic demand, the percentage change in a quantity of demand is less than one. Luxury goods have elastic demand, while necessities have an inelastic demand.
Uses of elastic demand
Here are some of the uses of elastic demand:
Change in wages
The ability of trade unions to raise wages depends on the elasticity of the demand for the products where labour is a major input. If wages are permitted to rise, then costs and prices would rise as well. A wage increase would cause production costs to rise and result in a rise in product prices.
Understanding business management problems
Elastic goods are more sensitive to price increases, while inelastic goods are less sensitive. Assuming there are no costs associated with producing the product, most businesses simply increase the price until there is a decline in demand. In such scenarios, the introduction of additional costs becomes complex.
Air transportation demand is determined by the purchasing power of the customer. Lower fares can increase the total revenue since the demand for air travel is elastic. Externalities, wage inequality and monetary and federal policies heavily impact the airline industry as well.
Importance of elastic demand
Here are some of the areas that highlight the importance of elasticity of demand:
Elastic demand is highly important for determining the terms and conditions of foreign trade. Inelastic demand can result in heavy duties being imposed on its import and export if professionals deem it inelastic. A country's terms of trade would be favourable if its exports benefit from an inelastic demand in the global market.
Elastic demand is useful in determining factor prices. Factor price is the unit cost of the use of a factor of production, like labour or capital. The factor of a product whose demand is inelastic can command a greater price than one whose demand is elastic.
The elasticity of demand concept is an important consideration when forming government policies, particularly in terms of taxation. Governments can apply a higher tax to goods with inelastic demand while applying a lower tax rate to goods with elastic demand. There is no significant impact on demand, therefore high taxes are justified in inelastic goods.
Transport demand elasticity refers to the ability to respond to a change in a factor affecting the demand for a transport mode. There would be a greater price elasticity for a particular transport service if there is a greater number of alternative modes available and if they all meet the same fundamental travel need. There are several factors that determine the price elasticity of transport demand, including the number and nearness of alternative modes or substitutes, the proportion and timing of disposable income spent on the mode of travel and the time dimension.
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