Elasticity Concept

Price Elasticity of Demand (PED) is the measure of the degree of responsiveness of a good or service to changes of its own price, ceteris paribus. It measures the extent of the shift of the demand curve as the price of the good changes. PED is the percentage change of the quantity demanded divided by the percentage change of the price.

PED is always have a negative value, this is because of the law of demand which states that an inverse relationship exist between the price and the quantity demanded of the good. When |PED|<1, the demand for the good is price inelastic. Hence, a change in price would lead to a less than proportionate increase in the quantity demanded for the good. When |PED|>1, the demand for the good is price elastic, a change in the price of the good would results in a more that proportionate change in the quantity demanded for the good.

The determinants for the price elasticity of demand are the time period, the number of substitutes, the proportion of income spent on the good, Addiction or habit, the nature of the good. For instance, when the there is a great number of substitutes for the good, the demand for the good would be price elastic, hence by decreasing its price, it would result in a more that proportionate change in quantity demanded.

PED is useful in explaining the pricing policy that an entrepreneurship should adopt. This is because when the demand for the good is price inelastic, increasing the price of the good would lead to a less than proportionate change in the quantity demanded, whereas when the demand for the good is price elastic, by decreasing its price, it would lead to a more than proportionate change in the quantity demanded. Therefore, on both situations, the entrepreneur would be able to earn more revenue.

However, there are some limitations of the PED concept as it does not depict what is the profit the entrepreneur is experiencing. It only helps to maximise sales and revenue.

Income elasticity of demand (YED) is the measure of the degree of responsiveness of the change in quantity demanded for the good to changes of the consumers' income level, ceteris paribus. It measures the extent of the shift of the demand curve as the income of the consumers changes. YED is calculated by the percentage change of the quantity demanded divided by the percentage change of the income level.

YED can be positive or negative depending on the nature of the good. When |YED|<1, the demand for the good is income inelastic, a change in income level would result in a less than proportionate change in quantity demanded for the good. When |YED|> 1, the demand for the good is income elastic, a change in income would lead to a more than proportionate change in the quantity demanded.

The determinants of YED are the level of consumer income and the nature of good. For instance, when there is increasing affluence in a country, this would mean a higher income level for the consumers, therefore the demand for normal goods would increase, however the demand of inferior goods would decrease. However, this does not always apply as for every social class, a normal good might be considered as an inferior good for a rich person, an inferior good might also be deemed as a luxury good for the impoverished people.

YED is useful in explaining and determining the output levels of each the good. When there is an economic boom, the firms would release new products as the consumers would have larger buying power, however when there is an economic recession, the firm would provide no frills and less-cost products to suit the income levels of consumers.

However, the YED is not entirely useful, this is because it is assumed ceteris paribus, where it measures that point of time and does not reflect the constantly varying elasticities, hence it is not an accurate representation of the elasticity concept.