Elasticity of Demand: Price, Income, and Cross elasticity

Elasticity of demand refers to the degree of responsiveness of quantity demanded to changes in its determinants. It mainly measures how much quantity demanded changes due to change in price, income, or prices of related goods. Price elasticity of demand shows the response of demand to change in price. Income elasticity shows effect of income change on demand, while cross elasticity shows effect of price change of related goods. Elasticity of demand is an important concept in business economics because it helps firms in pricing decisions, tax policy, demand forecasting, and revenue planning. For Indian businesses, understanding elasticity helps in setting suitable prices and avoiding loss of sales.

Price Elasticity of Demand (PED)

Price Elasticity of Demand refers to the degree of change in quantity demanded of a good due to change in its price, other factors remaining constant. It shows how sensitive consumers are to price changes. If a small change in price leads to a large change in demand, demand is elastic. If demand changes very little with price change, it is inelastic. Price elasticity of demand helps firms in fixing prices, deciding discounts, and predicting total revenue. In India, demand for essential goods is generally inelastic, while luxury goods have elastic demand.

Price Elasticity of Demand measures how much quantity demanded responds to a change in price.

Formula:

PED = % Change in Quantity Demanded / % Change in Price​

Or, in a more detailed form:

PED = ΔQ/Q / ΔP/P​

Where:

ΔQ = Change in quantity demanded

Q = Initial quantity demanded

ΔP = Change in price

P = Initial price

Interpretation:

• PED > 1 → Elastic demand

• PED < 1 → Inelastic demand

• PED = 1 → Unit elastic demand

Income Elasticity of Demand (YED)

Income Elasticity of Demand (YED) measures the responsiveness of quantity demanded of a good to a change in consumer income, other factors remaining constant. It indicates how demand changes when income rises or falls. If demand increases with a rise in income, the good is called a normal good. If demand decreases as income rises, it is an inferior good. YED is calculated as the percentage change in quantity demanded divided by percentage change in income. This concept is important for business decisions, helping firms predict changes in demand due to income variations. In India, demand for luxury cars and branded products shows high positive YED, while basic food items have low YED.

Income Elasticity of Demand (YED)

Income Elasticity of Demand measures how quantity demanded changes in response to a change in consumer income.

Formula:

YED = % Change in Quantity / Demanded% Change in Income​

Or, in detailed form:

YE = ΔQ/Q / ΔI/I

Where:

ΔQ = Change in quantity demanded

Q = Initial quantity demanded

ΔI = Change in income

$I$ = Initial income

Interpretation:

• YED > 0 → Normal goods

• YED < 0 → Inferior goods

• YED > 1 → Luxury goods

Cross Elasticity of Demand (XED):

Cross Elasticity of Demand (XED) measures the responsiveness of demand for one good to a change in the price of another related good, keeping other factors constant. It helps identify whether goods are substitutes or complements. If XED is positive, the goods are substitutes, meaning an increase in the price of one increases demand for the other, like tea and coffee. If XED is negative, the goods are complements, meaning an increase in the price of one reduces demand for the other, like printers and ink cartridges. XED helps firms in pricing, product strategy, and understanding market competition.