We have discussed in previous chapters that when the price of a good falls, its quantity demanded rises and when the price of the good rises, its quantity demanded falls. This is generally known as law of demand. This law of demand indicates only the direction of change in quantity demanded in response to a change in price. This does not tell us by how much or to what extent the quantity demanded of a good will change in response to a change in its price. This information as to how much or to what extent the quantity demanded of a good will change as a result of a change in its price is provided by the concept of elasticity of demand. The concept of elasticity has a very great importance in economic theory as well as in engineering economics.

VARIOUS CONCEPTS OF DEMAND ELASTICITY

It is price elasticity of demand which is usually referred to as elasticity of demand. But, besides price elasticity of demand, there are various other concepts of demand elasticity. As we have seen in earlier chapters that demand for a food is determined by its price, incomes of the people, prices of related goods, etc. Quantity demanded of a good will change as a result of a change in the size of any of these determinants of demand. The concept of elasticity of demand therefore refers to the degree of responsiveness of quantity demanded of a good to a change in its price, income or prices of related goods. Accordingly, there are three kinds of demand elasticity : price elasticity, income elasticity, and cross elasticity.

Price elasticity of demand relates to the responsiveness of quantity demanded of a good to the change in its price. Income elasticity of demand refers to the sensitiveness of quantity demanded to the change in income. Gross elasticity of demand means the degree of responsiveness of demand of a good to a change in the price of a related good, which may be either a substitute for it or a complementary with it. Besides these three kinds of elasticities there is another type of elasticity of demand called elasticity of substitution which refers to the change in quantity demanded of a good in response to the change in its relative price alone, real income of the individual remaining the same.

PRICE ELASTICITY OF DEMAND

Price elasticity means the degree of responsiveness or sensitiveness of quantity demanded of a good to changes in its prices. In other words, price elasticity of demand is a measure of the relative change in quantity purchased of a good in response to a relative change in its price. Price elasticity can be precisely defined as “the proportionate change in quantity demanded in response to a small change in price, divided by the proportionate change in price”. Thus,

Mathematically speaking, price elasticity of demand (cp) is negative, since the change- in quantity demanded is in opposite direction to the change in price. When price falls, quantity demanded rises and vice versa. But for the sake of convenience in understanding the magnitude of response of quantity demanded to the change in price we ignore the negative sign and take into account only the numerical value of the elasticity. Thus if 2% change in price leads to 4% change in quantity demanded of good A and 8% change in that of B, then the above formula of elasticity will give the value of price elasticity of good A equal to 2 and of good B equal to 4. It indicates that the quantity demanded of good B changes much more than that of good A in response to a given change in price. But if we had written minus signs before the numerical values of elasticities of two goods, that is, if we had written the elasticities as —2 and —4 respectively as strict mathematics would require us to do, then since —4 is smaller than —2, we would have been misled in concluding that price elasticitiy of demand of B is less than that of A.