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Elasticity (economics)

What is 'Demand Elasticity/Elasticity of Demand'

❶Business Jargons A Business Encyclopedia. Therefore, given the time, they can substitute the material whose price has risen.

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Determinants of Elasticity of Demand
BREAKING DOWN 'Demand Elasticity/Elasticity of Demand'

Such as, if the commodity is used for a single purpose, then the change in the price will affect the demand for commodity only in that use, and thus the demand for that commodity is said to be inelastic. Whereas, if the product has several uses, such as raw material coal, iron, steel, etc.

Thus, the demand for such products is said to be elastic. Whether the Demand can be Postponed or not: If the demand for a particular product cannot be postponed then, the demand is said to be inelastic. Such as, Wheat is required in daily life and hence its demand cannot be postponed. On the other hand, the items whose demand can be postponed is said to have elastic demand. Such as the demand for the furniture can be postponed until the time its prices fall.

The substitutes are the goods which can be used in place of one another. The goods which have close substitutes are said to have elastic demand. Such as, tea and coffee are close substitutes and if the price of tea increases, then people will switch to the coffee and demand for the tea will decrease significantly.

Whereas, if there are no close substitutes for a product, then its demand is said to be inelastic. Such as salt and sugar do not have their close substitutes and hence lower is their price elasticity. The elasticity of demand also depends on the complementary goods, the goods which are used jointly. Such as car and petrol, pen and ink, etc. Here the elasticity of demand of secondary supporting commodity depends on the elasticity of demand of the major commodity.

Such as, if the demand for pen is inelastic, then the demand for the ink will also be less elastic. The price range in which the commodities lie also affects the elasticity of demand. Such as the higher range products are usually bought by the rich people, and they do not care much about the change in the price and hence the demand for such higher range commodities is said to be inelastic. This method for computing the price elasticity is also known as the "midpoints formula", because the average price and average quantity are the coordinates of the midpoint of the straight line between the two given points.

However, because this formula implicitly assumes the section of the demand curve between those points is linear, the greater the curvature of the actual demand curve is over that range, the worse this approximation of its elasticity will be.

Together with the concept of an economic "elasticity" coefficient, Alfred Marshall is credited with defining PED "elasticity of demand" in his book Principles of Economics , published in If it is slow But if it is rapid, a small fall in price will cause only a very small increase in his purchases. In the former case In the latter case The overriding factor in determining PED is the willingness and ability of consumers after a price change to postpone immediate consumption decisions concerning the good and to search for substitutes "wait and look".

On a graph with both a demand curve and a marginal revenue curve, demand will be elastic at all quantities where marginal revenue is positive. Demand is unit elastic at the quantity where marginal revenue is zero. Demand is inelastic at every quantity where marginal revenue is negative. A firm considering a price change must know what effect the change in price will have on total revenue. Revenue is simply the product of unit price times quantity:. Generally any change in price will have two effects: For inelastic goods, because of the inverse nature of the relationship between price and quantity demanded i.

But in determining whether to increase or decrease prices, a firm needs to know what the net effect will be. Elasticity provides the answer: The percentage change in total revenue is approximately equal to the percentage change in quantity demanded plus the percentage change in price. One change will be positive, the other negative. As a result, the relationship between PED and total revenue can be described for any good: Hence, as the accompanying diagram shows, total revenue is maximized at the combination of price and quantity demanded where the elasticity of demand is unitary.

It is important to realize that price-elasticity of demand is not necessarily constant over all price ranges. The linear demand curve in the accompanying diagram illustrates that changes in price also change the elasticity: PEDs, in combination with price elasticity of supply PES , can be used to assess where the incidence or "burden" of a per-unit tax is falling or to predict where it will fall if the tax is imposed. For example, when demand is perfectly inelastic , by definition consumers have no alternative to purchasing the good or service if the price increases, so the quantity demanded would remain constant.

Hence, suppliers can increase the price by the full amount of the tax, and the consumer would end up paying the entirety. In the opposite case, when demand is perfectly elastic , by definition consumers have an infinite ability to switch to alternatives if the price increases, so they would stop buying the good or service in question completely—quantity demanded would fall to zero.

As a result, firms cannot pass on any part of the tax by raising prices, so they would be forced to pay all of it themselves.

In practice, demand is likely to be only relatively elastic or relatively inelastic, that is, somewhere between the extreme cases of perfect elasticity or inelasticity. More generally, then, the higher the elasticity of demand compared to PES, the heavier the burden on producers; conversely, the more inelastic the demand compared to PES, the heavier the burden on consumers.

The general principle is that the party i. Among the most common applications of price elasticity is to determine prices that maximize revenue or profit. If one point elasticity is used to model demand changes over a finite range of prices, elasticity is implicitly assumed constant with respect to price over the finite price range.

The equation defining price elasticity for one product can be rewritten omitting secondary variables as a linear equation. Constant elasticities can predict optimal pricing only by computing point elasticities at several points, to determine the price at which point elasticity equals -1 or, for multiple products, the set of prices at which the point elasticity matrix is the negative identity matrix. The fundamental equation for one product becomes.

Excel models are available that compute constant elasticity, and use non-constant elasticity to estimate prices that optimize revenue or profit for one product [38] or several products. In most situations, revenue-maximizing prices are not profit-maximizing prices.

For example, if variable costs per unit are nonzero which they almost always are , then a more complex computation of a similar kind yields prices that generate optimal profits. In some situations, profit-maximizing prices are not an optimal strategy. For example, where scale economies are large as they often are , capturing market share may be the key to long-term dominance of a market, so maximizing revenue or profit may not be the optimal strategy.

Various research methods are used to calculate price elasticities in real life, including analysis of historic sales data, both public and private, and use of present-day surveys of customers' preferences to build up test markets capable of modelling such changes.

Alternatively, conjoint analysis a ranking of users' preferences which can then be statistically analysed may be used. This approach has been emprirically validated using bundles of goods e. Though PEDs for most demand schedules vary depending on price, they can be modeled assuming constant elasticity.

For suggestions on why these goods and services may have the PED shown, see the above section on determinants of price elasticity. From Wikipedia, the free encyclopedia. An automated process has detected links on this page on the local or global blacklist. If the links are appropriate you may request whitelisting by following these instructions ; otherwise consider removing or replacing them with more appropriate links.

To hide this tag, set the "invisible" field to "true" List of blacklisted links: For income elasticity, see income elasticity of demand. For cross elasticity, see cross elasticity of demand. For wealth elasticity, see wealth elasticity of demand. It is not to be confused with Price elasticity of supply. Retrieved 27 February Archived from the original on 13 January Retrieved 26 April Rogers in Duetsch , p.

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Definition: The Elasticity of Demand is a measure of sensitiveness of demand to the change in the price of the commodity. Determinants of Elasticity of Demand Apart from the price, there are sever Apart from price, there are several factors that influence the elasticity of demand.

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The first two determinants are important to both price elasticity of demand and price elasticity of supply, while the third relates specifically to the price elasticity of demand. Three elasticity determinants are: availability of substitutes, time period, and proportion of budget.

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Definition of price elasticity (PES) to supply refers to a measurement of relationship between change in quantity supplied and a change in price. There is a few determinants that affects the outcome of the PES. We will look at how quantity demanded and supplied respond to their key determinants in quantitative (elasticity) as well as qualitative terms. The last two weeks of the first module will investigate consumer behavior more closely and show how consumer choices are driven by the interplay of preferences and budget constraints.

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What is 'Demand Elasticity/Elasticity of Demand' In economics, the demand elasticity (elasticity of demand) refers to how sensitive the demand for a good is to changes in other economic variables. Price elasticity of demand (PED or E d) is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price when nothing but the price changes. More precisely, it gives the percentage change in quantity demanded in response to a one percent change in price.