What do you understand by Elasticity of Demand? And what are the factors that affecting Elasticity of Demand ? Illustrate.
ELASTICITY OF DEMAND -
The law of demand tells us that there is an inverse relationship between price of a commodity and its quanti demanded i.e. increase in price reduces the quantity and vice versa, However, this law is silent on how much increase or decease in quantity will take place on account of a given change in price. The change in quantity may be high or low on account of a given price change and the measurement of this change is called elasticity of demand.
Definition of Elasticity of Demand -
"Elasticity of demand is the measure of responsiveness of quantity demanded to change in price.”
The elasticity can be measured by the following formula,
Elasticity of Demand =
Proportionate Change in Quantity Demanded / Proportionate Change in Price
Ed = (Q. - Q/Q) / Q / (P1 - P)/P
Ed = Elasticity of demand
Q = Original quantity demanded
Q1 = New quantity demanded
P = Original Price
P1 = New Price
Factors Affecting Elasticity of Demand -
We have know that the elasticity of different goods is different. Generally, elasticity of necessities is low while that comforts and luxuries is high. But elasticity is not dependent this factor alone. In fact, there are many factors and the given elasticity is the combined effect of all these factors. We now see all these factors.
1. Nature of Commodity :
From this viewpoint we may divide goods in three categories.
From the viewpoint of economics, necessities are all those goods without which the work capability and efficiency of a person is very much adversely affected. Those goods which somewhat increase work capability are comforts and those goods which only provide satisfaction but do not affect work capability and efficiency, or may even affect it adversely, are called luxuries. As already indicated, necessities have low elasticity, comforts have more elasticity and luxuries have high elasticity and am very much sensitive to price changes.
2. Money Spent on a Commodity:
Elasticity of demand form a commodity also depends upon the factor that what proportion of consumer's income is being spent on the commodity. If only a small fraction of income is being spent, then the demand will be generally inelastic because the change of price will have a negligible effects on the consumer.
For example, the increase in the price of a Post-Card will not reduce its demand, because the consumer spends a negligible portion of his income Post-Cards and due to price increase even if he has pay something extra, he won't mind it.
3. Availability of Substitutes :
Elasticity of Demand also depends upon the fact that substitute goods are available or not. If substitute goods are available elasticity is higit because the given good can be easily replaced. Hence, we can say that demand for a commodity is highly sensitive to price changes if substitute goods are available.
4. Multiple Uses of a Commodity :
If a commodity has multiple uses, then this commodity generally has relative higher elasticity as compared to another commodity which has only a single use. If there are multiple uses then due to any price increase, its use can be immediately reduced where it is not so important.
For example, plastc has multiple uses like furniture making, decorative pieces baggages, utility goods etc. Therefore, its demand is relatively more elastic.
5. Possibility of Postponement of Consumption:
Elasticity of demand is also dependent on the fact that whether its use can be postponed or not. If its use is postponable, then due to any price rise, the person immediately suspends its use and demand immediately comes down. If it is an urgent commodity and its use can not be postponed, the person concerned will definitely have to consume that commodity, even if its price rises, and accordingly the demand will be inelastic.
6. Price Level and Extent of Price Change :
The price level of a commodity may also affect its elasticity. If the price is low, then any price rise does not affect the consumer much and he tends to absorb that price change. If price level is high, any increase in price makes the consumer show a reaction and he reduces its demand. Similarly, extent of price change also affects the elasticity. If price change is small, it does not affect the consumer as he psychologically tends to ignore this small change. However, if the price change is large, then consumer can not but be effected by this price change, and therefore, his demand would become elastic.
7. Time Element :
Time element also affects the elasticity. In the short term elasticity is generally low and in the long term it is high. The reason is that, in the short term the consumer does not have much time to adjust his consumption to the changed price, but in the long run he has ample time to adjust his consumption to the changed price and his elasticity will be high.
The law of demand tells us that there is an inverse relationship between price of a commodity and its quanti demanded i.e. increase in price reduces the quantity and vice versa.