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Concepts of Elasticity

The discussion so far has been concerned with broad direction of relationship between price changes, changes in other possible determinants of demand and the quantity demand. However, in addition to understanding the nature of demand, it would of course be very useful if management were able to estimate the extent to which demand is likely to respond to a price changed. Gauging this, responsiveness is referred to by economists as the measurement of price elasticity. In addition, since, as we have seen, demand is affected by many factors, we can calculate elasticity (i.e., responsiveness of quantity demanded) with respond to a wide range of variables other than price, notably the price of the other goods and income. Thus, we can define, notably the price of other goods and income. Thus, we can define the following.

1. Price elasticity of demand: This measures the responsiveness of quantity demand of a product to changes in its ‘own price’. For example, if the price of alcohol increases, what happen to the quantity of alcohol demand?

2. Cross-price elasticity of demand: This measure the responsiveness of quantity demanded to changes in the price of other good (both complements and substitutes).

For example, if the price one brand of coffee rises, what happens to the demand for another coffee brand? Or, if the price of petrol falls, what happens to the demand for cars?

3. Income elasticity of demand: This measures the responsiveness of demand to a change in the real income of consumers. For example, if real incomes are rising on average, by $ 500 per month, what will happen to the demand for housing?

In general terms, a coefficient of elasticity can be calculated for each of the above categories using the following general formula”