A Business Encyclopedia

Elasticity of Demand

Definition: The Elasticity of Demand is a measure of change in the quantity demanded in response to the change in the price of the commodity. Simply, the effect of a change of price on the quantity demanded is called as the elasticity of demand.

Marshall, a renowned economist, has suggested a mathematical method  to measure the elasticity of demand:

Elasticity of demand-1According to this formula, the elasticity of demand can be defined as a percentage change in demand as a result of the percentage change in price. Numerically, it can be written as:

Elasticity of demand-2Where,
ΔQ = Q1 –Q0
ΔP = P1 – P0
Q1= New quantity
Q2= Original quantity
P1 = New price
P0 = Original price

Importance of Elasticity of Demand

  • The concept of demand elasticity helps in understanding the price determination by the monopolist. A monopoly is the market structure wherein there is only one seller whose main objective is to maximize the profits. The price he chooses for his product depends on the elasticity of demand. Such as, if the demand for a commodity is high he can choose the higher price as the consumers will buy the product even when the price rise. But however, if the demand is elastic, he will choose the lower prices.
  • The determination of the price depends on demand for and supply of the commodity. But however, the demand is governed by the demand elasticity and the supply too is governed by the elasticity of supply. Therefore, the price of a commodity depends on both the demand and supply elasticity.
  • The concept of demand elasticity also helps in understanding other types of prices, such as exchange rates, i.e. a rate at which currency unit of one country is exchanged for the currency unit of another country. Also, the terms of trade, i.e. the rate at which the exports are changed for imports can be easily understood through this concept.
  • The concept of elasticity of demand also helps the government in its taxation policies. This helps the government to have a fair idea about the demand elasticity of goods which are being taxed.
  • This concept also helps in the determination of wages, such as if the demand for labor is inelastic the union can demand higher wages and conversely if the labor demand is elastic the demand for higher wages could not be raised.

Thus, the concept of elasticity of demand is very important to understand the economic problems and policies. This is very well elucidated through the points explained above.

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