Elasticity of Demand – SS2 Economics Lesson Note (First Term)

The elasticity of demand may be defined as the degree of responsiveness of demand to changes in price, income, prices of other commodities and similar factors.

Behavioural objectives

By the end of the lesson, students should be able to:

• define elasticity of demand and name its three types;
• calculate the coefficient of price elasticity of demand;
• describe the five types of price elasticity of demand and state the coefficient of each;
• state the factors that determine elasticity of demand.

What are the types of elasticity of demand?

1. Price elasticity of demand
2. Income elasticity of demand
3. Cross elasticity of demand

What is price elasticity of demand?

Price elasticity of demand is the degree of responsiveness of demand for a particular commodity to changes in its price. It is the rate at which the quantity demanded changes as its price changes.

How is price elasticity of demand measured?

To measure price elasticity of demand (PED), we use the formula:

PED = % change in quantity demanded ÷ % change in price

The formula can be broken down as follows:

• % change in quantity demanded = (change in quantity ÷ old quantity) × 100
• % change in price = (change in price ÷ old price) × 100

The change is the difference between the old value and the new value.

Illustration

When the price of a given product is reduced from ₦90 to ₦80, the quantity demanded increases from 50 to 60 units. Deduce the coefficient of elasticity of demand.

Solution

Old price = ₦90, new price = ₦80

Change in price = 80 – 90 = -10

% change in price = (10 ÷ 90) × 100 = 11.1%

Old quantity = 50, new quantity = 60

Change in quantity = 60 – 50 = 10

% change in quantity = (10 ÷ 50) × 100 = 20%

PED = 20 ÷ 11.1 = 1.8

What are the types of price elasticity of demand?

The types of price elasticity of demand and their graphical representation are shown below.

1. Perfectly elastic (or infinitely elastic) demand

Consumers react sharply to changes in price. They are willing to buy all the goods available at a particular price and none at all at a slightly higher price. The coefficient of elasticity tends to infinity.

2. Perfectly inelastic (or zero elasticity) demand

When the quantity demanded remains the same regardless of the price change, demand is said to be perfectly inelastic. The coefficient of elasticity is zero.

3. Unitary (or unity) elasticity of demand

This is the situation where a change in price or income brings about the same percentage change in the quantity demanded. The coefficient of elasticity of demand is equal to 1.

4. Fairly elastic demand

In this case, a small percentage change in price gives rise to a more than proportionate change in the quantity demanded. For example, where a 20% fall in price leads to a 50% rise in demand, the coefficient of elasticity is greater than 1 but less than infinity.

5. Inelastic demand (fairly inelastic demand)

When a change in the price of a commodity leads to a less than proportionate change in the quantity demanded, demand is inelastic. For example, a 15% increase in price brings about a 10% decrease in the quantity demanded. The coefficient of elasticity is less than 1 but greater than zero.

What factors determine elasticity of demand?

1. Availability of close substitutes: A commodity that has close substitutes is likely to have an elastic demand.
2. Degree of necessity of the goods: If a commodity is a necessity or a near-necessity, an increase or decrease in its price is not likely to affect its demand.
3. Proportion of consumer income spent on the commodity: Generally, the larger the proportion of income spent on a commodity, the more elastic the demand for it.
4. Habit: If a consumer has become addicted to a commodity, his demand for the good will tend to be inelastic. An increase in the price of the commodity may therefore not reduce the quantity demanded.
5. Level of consumer income: The larger the income of the consumer, the more inelastic his demand for commodities. On the other hand, the demand of consumers with low income tends to be elastic.
6. Cheap commodities: The cost of some commodities is relatively insignificant, so consumers’ demand for them will be inelastic.

Evaluation

1. Define elasticity of demand.
2. Name the three types of elasticity of demand.
3. State the formula for price elasticity of demand.
4. State the coefficient of elasticity for perfectly inelastic demand and for unitary elasticity of demand.
5. List four factors that determine elasticity of demand.

Assignment

1. If the elasticity of supply is greater than 1, supply is (a) unitary elastic (b) inelastic (c) elastic (d) infinitely elastic.
2. When the demand curve is a straight line parallel to the x-axis, demand is (a) fairly elastic (b) fairly inelastic (c) perfectly elastic (d) perfectly inelastic.
3. If the elasticity of demand for a commodity is less than 1, demand is (a) unitary elastic (b) inelastic (c) infinitely elastic (d) zero elastic.
4. If the price of a commodity rises from ₦2 to ₦4 and its demand decreases from 125 to 100, the coefficient of elastic demand is (a) 0.02 (b) 0.20 (c) 0.25 (d) 5.
5. For a good having close substitutes, the price elasticity of demand is likely to be (a) zero (b) negative (c) more than (d) less than.