The elasticity of demand is a measure of how responsive the quantity demanded of a product or service is to changes in its price. It is the percentage change in the quantity demanded of a product or service in response to a 1% change in its price.
The concept of elasticity of demand is important in economics because it helps businesses and policymakers understand how consumers react to changes in prices. If the demand for a product is highly elastic, even a small increase in its price can lead to a large decrease in its quantity demanded. On the other hand, if the demand for a product is highly inelastic, a price increase may not significantly affect the quantity demanded.
The formula for calculating the price elasticity of demand
Price elasticity of demand = (percentage change in quantity demanded) / (percentage change in price)
When the result of this formula is greater than 1, demand is considered elastic, meaning that a change in price has a significant impact on the quantity demanded. When the result is less than 1, demand is considered inelastic, meaning that a change in price has a relatively small impact on the quantity demanded. If the result is exactly 1, demand is considered unit elastic, meaning that a change in price has a proportional impact on the quantity demanded.
FACTORS AFFECTING ELASTICITY OF DEMAND AND THE IMPORTANCE OF ELASTICITY OF DEMAND
What are the factors affecting the elasticity of demand?
The following factors are what affect the elasticity of demand
- The income of the consumer: The higher the consumer’s income, the more inelastic his demand for goods and services will tend to be.
- Close substitute of a commodity: Commodities which have close substitutes tend to have a high price elasticity of demand while those that do not have close substitutes are likely to be inelastic.
- Nature of commodity: Whether the commodity is a necessity or a luxury item it will affect the elasticity of demand. Any item that is considered necessary will always be demanded even if the price is increased, i.e. the good is inelastic in demand. Luxury goods on the other hand are highly elastic in demand.
- One’s habit: When one forms a habit on the consumption of a commodity, a change in the price of that commodity will not affect one’s demand for it.
- Number of uses to which a commodity is put: It is known that the more commodities can be put into several the more elastic the demand becomes and vice versa.
IMPORTANCE OF ELASTICITY OF DEMAND
- Increase in revenue: It helps producers or sellers to increase their revenue in a bid to raise the prices of a commodity. This will depend on whether their goods are inelastic
- Determination of maximum output: also helps the producers to determine the maximum output to produce in order to ensure higher turnover and profit.
- Determination of cross elasticity: helps the producer to determine which goods to produce more when goods the same substitutes exist.
- Imposition of taxes by government Elasticity of demand helps die government in determining the imposition of taxes on goods and services.
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