Elastic and inelastic demand, the concept of elasticity

Demand is the volume of goods or services that buyers are willing to buy at current prices for a certain time. Between the demand for the product and its price there is the following relationship: the higher the price, the less the number of consumers wants to buy it - and vice versa. This dependence is called the "law of demand".

However, for economists and analysts it is not enough just to foresee how the change in current prices will affect the amount of demand . The degree of such a change is of great importance. The strength with which there is a change in demand, depending on various factors, is called "elasticity of demand." There are several types of such elasticity: price, cross and income elasticity. Each type has its own characteristics.

Price elasticity shows how the demand varies depending on price fluctuations, and is expressed through the elasticity coefficient :

Ed = (ΔQ / Q): (ΔP / P), where

ΔQ / Q - change in the number of purchased goods,

ΔP / P is the change in the value of this product.

Also, the elasticity of demand can be calculated as a percentage:

Ed =% Q /% P, where

% Q - percentage increase or decrease in demand,

% P - percentage increase or decrease in price.

This ratio shows how the demand will change if the price of the goods increases or decreases by 1%.

Cross-elasticity, in turn, characterizes the level of dependence of demand for the first product, depending on the fluctuations in the value of the other. The formula for this indicator is as follows:

Eab = (ΔQa / Qa): (ΔPb / Pb), where

ΔQa / Qa - change in demand for the first product a,%;

ΔPb / Pb - change in the price of the second product b,%.

Elasticity in income is similar to the elasticity of the price, but the role of the factor that influences the level of demand now is the amount of income.

Ei = (ΔQ / Q): (ΔI / I), where

ΔQ / Q - change in the number of goods sold,

ΔI / I - relative change in income level.

Depending on the received coefficient, these types of elasticity are distinguished:

1. Ed = 0.

In this case, we have absolutely inelastic demand. The zero value of the coefficient means that price fluctuations do not affect the quantity of goods purchased. As a rule, these are irreplaceable medical preparations, for example, insulin.

2. Ed <1.

If the value obtained is in the range from 0 to 1, then this means inelastic demand. Consequently, the increase in prices will have a weak effect on sales volumes. If the firm decides to reduce the margin for goods with inelastic demand, then instead of the expected increase in sales, it will receive a decrease in revenue. Examples of goods with inelastic demand are food products, as well as essential goods.

3. Ed = 1.

With a single elasticity, the price change does not affect the amount of revenue. In this case, it has the maximum size. An example is the demand for various transportation services, which has the property of changing equally with the variation in the cost of travel.

4. Ed> 1.

Elastic demand, which significantly depends on price fluctuations. Firms who sell such products are advised to reduce prices for their products, as this will increase the revenue from the sale.

5. Ed = ∞.

This means that the demand for this product is characterized by an absolute elasticity. At stable prices, there is a periodic change in demand for this product. Luxury goods can serve as an example of such goods.

The elastic and inelastic demand is influenced by various factors. The most important of them are the following:

• the number of substitutes for such a product. If the product has many good substitutes, then the elasticity will be high;

• the specific weight of such a product in the income of the buyer. The relationship is directly proportional: the higher the specific gravity, the higher the elasticity;

• the importance of the goods for the consumer - whether the product is a luxury item or it is an everyday product. Undoubtedly, the demand for luxury goods is more elastic;

• time factor. The more time a buyer has, the greater the elasticity.