Elasticity of Demand
How to measure exactly how responsive quantity demanded is to price, income, and related prices.
Definition
Elasticity of demand measures the degree of responsiveness of quantity demanded to a change in one of its determinants — most commonly its own price, but also income or the price of a related good.
Simple Explanation
The law of demand only tells you which direction quantity demanded moves; elasticity tells you by how much.
Detailed Explanation
There are three elasticities tested at this level: Price Elasticity of Demand (Ed, responsiveness to the good's own price), Income Elasticity of Demand (Ey, responsiveness to income), and Cross Elasticity of Demand (Exy, responsiveness to the price of a related good). Each is calculated as a ratio of percentage changes, which is what makes elasticity unit-free and comparable across very different goods.
Price elasticity is classified into five degrees based on its numerical value: perfectly elastic (Ed = ∞, a horizontal demand curve — even a tiny price change causes infinite change in quantity), relatively elastic (Ed > 1), unitary elastic (Ed = 1), relatively inelastic (Ed < 1), and perfectly inelastic (Ed = 0, a vertical demand curve, where quantity demanded never changes regardless of price).
Several factors determine how elastic a good's demand is: the availability of close substitutes (more substitutes, more elastic), whether the good is a necessity or a luxury (necessities tend to be inelastic), the proportion of income spent on the good (a bigger budget share usually means more elastic demand), and the time period under consideration (demand is typically more elastic in the long run, once consumers can fully adjust).
Beyond the percentage method, CBSE also tests the geometric (point) method of measuring price elasticity directly off a linear demand curve: at any point on the line, elasticity equals the length of the segment of the curve BELOW that point divided by the length of the segment ABOVE it (lower segment ÷ upper segment). This lets you read off elasticity visually without a numerical table.
Elasticity is not just an abstract number — it directly drives real decisions. A firm raising the price of a good with elastic demand will see total revenue fall, while raising the price of an inelastic good raises total revenue, which is exactly why governments prefer to tax inelastically-demanded goods (like fuel or tobacco) to raise revenue with minimal change in the quantity consumed.
Real-life Examples
Inelastic: petrol
Petrol has very few practical substitutes for most vehicle owners, so even a sharp price rise barely changes the quantity bought — low (inelastic) price elasticity.
Elastic: a specific smartphone brand
With many rival smartphone brands available, a price rise on one specific brand can cause a large swing in its quantity demanded — high (elastic) price elasticity.
Step-by-step Graph
- 1
Draw a linear demand curve
Plot a straight-line demand curve meeting the Y-axis and X-axis at two points.
- 2
Mark a point on the line
Choose any point P on the demand curve where you want to measure elasticity.
- 3
Identify the two segments
The curve is now divided into a lower segment (from P down to the X-axis intercept) and an upper segment (from P up to the Y-axis intercept).
- 4
Apply the ratio
Price elasticity at P = length of the lower segment ÷ length of the upper segment. A ratio greater than 1 means elastic; less than 1 means inelastic; exactly 1 (the curve's midpoint) means unitary elastic.
Formulas
Price Elasticity of Demand
Ed = (% change in Qd) / (% change in Price)
Measures responsiveness of quantity demanded to a price change.
Income Elasticity of Demand
Ey = (% change in Qd) / (% change in Income)
Measures responsiveness of quantity demanded to an income change.
Cross Elasticity of Demand
Exy = (% change in Qd of X) / (% change in Price of Y)
Measures how demand for X responds to a price change in a related good Y.
Tables
| Degree | Value of Ed | Demand curve shape |
|---|---|---|
| Perfectly elastic | Ed = ∞ | Horizontal straight line |
| Relatively elastic | Ed > 1 | Flatter curve |
| Unitary elastic | Ed = 1 | Equilateral hyperbola |
| Relatively inelastic | Ed < 1 | Steeper curve |
| Perfectly inelastic | Ed = 0 | Vertical straight line |
| Type of good | Cross elasticity sign | Example |
|---|---|---|
| Substitutes | Positive | Tea and coffee |
| Complements | Negative | Car and petrol |
| Unrelated goods | Approximately zero | Rice and notebooks |
Common Mistakes
- Confusing 'elastic' (Ed > 1, a large response in quantity) with simply 'a large change in price'.
- Ignoring the negative sign convention for price elasticity — only its magnitude is usually compared.
- Assuming income elasticity is always positive — it is negative for inferior goods.
Exam Tips
- For elasticity numericals, write the formula first, then substitute — method marks are awarded even for an arithmetic slip.
- For the geometric method, always label the lower segment and upper segment clearly on the diagram before stating the ratio.
- State which measure of elasticity (price/income/cross) the question is asking for before you start calculating — they use the same percentage-method structure but different variables.
Summary
- Elasticity measures the degree of responsiveness of demand to price, income, or related prices.
- Price elasticity ranges across five degrees, from perfectly elastic to perfectly inelastic.
- Substitutes have positive cross elasticity; complements have negative cross elasticity.
- The geometric method reads elasticity off a linear demand curve as lower segment ÷ upper segment.
- Necessities tend to be inelastic; goods with many substitutes tend to be elastic.
Practice MCQs
1. If the cross elasticity of demand between two goods is negative, the goods are:
2. A demand curve that is a vertical straight line represents:
3. Necessities such as salt typically have:
4. Using the geometric (point) method, elasticity at a point on a linear demand curve equals:
5. Income elasticity of demand for an inferior good is:
6. A good with many close substitutes will typically have: