Question

Explain, in great detail elasticity in microeconomics. Provide examples.

Answer 1

Price elasticity of demand is the responsiveness of change in quantity demanded due to a change in prices of the goods.

This means that if the demand is more responsive to the change in prices, then the demand is more elastic. If the demand is less responsive to the change in prices, the demand is less elastic. It is given by the following formula:

Price elasticity of demand = % change in quantity demanded / % change in price

If the value of price elasticity of demand is more than 1 then it would be called elastic demand.

If the value of price elasticity of demand is less than 1 then it would be called inelastic demand.

If the value of price elasticity of demand is equal to 1 then it would be called unitary elastic demand.

Income elasticity of demand is the responsiveness of change in quantity demanded due to a change in the income of the consumers. It is given by the following formula:

Income elasticity of demand = % change in quantity demanded/ % change in income of the consumer.

Normal goods are the ones that have a direct relationship with the income of the consumers. Goods like food items, furniture, clothes, etc. The demand for these goods increases as the income of the consumers' increases.

Inferior goods are the ones that have an indirect relationship with the income of the consumers. Suppose an employee who takes a bus to go to work gets a promotion and then he switches from bus to cab. The bus here will be considered as the inferior good since its demand decreased with the increase in income of the consumer.

From the above definitions and the formula of income elasticity, we can see that normal goods have a positive income elasticity and the inferior goods have a negative income elasticity.

OR

If the value of income elasticity is positive, then the good is called normal good and if the income elasticity of demand is negative, the good is called an inferior good.

Cross price elasticity of demand is the responsiveness of change in quantity demanded of one good by the change in the price of another good. It is given by the following formula:

Cross price elasticity of demand for good A = % change in quantity demanded of good A/ % change in the price of good B

If the value of the cross-price elasticity of demand is positive then the goods will be substitutes. Substitutes are the goods that are used in place of one another like tea and coffee.

If the price elasticity of demand is negative then the goods are complements. Complement goods are the ones that are bought together like car and petrol, refill and pen etc.