281

se for

Elasticity of Demand
of Demand Elasticity
VariousConcepts
quantity
Wehavediscussedin the preceding chapter that when price of a good falls, its
known
demanded risesand when price of it rises, its quantity demanded falls. This is generally
of change in quantity
aslawof demand.This law of demand indicates only the direction us by how
demanded of a commodity in response to a change in its price. This does not tell
change in response to a change
muchor to what extent the quantity demanded of a good will
extent the quantity demanded of a
initsprice.This information as to how much or to what
provided by the concept of price elasticity
goodwillchange as a result of a change in its price is
of demand.
concepts of demand
But, besidesprice elasticity of demand, there are various other
is determined by its
As we have seen in the previous chapter, demand for a good
elasticity.
Quantity demanded of a good will
price,incomeof the people, prices of related goods, etc. elasticity
of demand. The concept of
changeas a resultof change in any of these determinants demanded of a
ofdemand thereforerefersto the degree of responsiveness of quantity
relatedgoods. Accordingly,
goodto a change in its price, consumers' income and prices of
income elasticity, and cross
thereare threeconcepts of demand elasticity : price elasticity,
responsiveness of quantity demanded
elasticity.Price elasticity of demand relates to the degree of sensitivenes of
demand refers to the
ofa goodto the change in its price. Income elasticity of
elasticityof demand means the
quantitydemandedto a change in consumers' income. Cross
in the price of a related good,
degreeof responsivenessof demand of a good to a change
with it.
whichmay be either a substitute for it or a complementary
great importance in economic theory as
The conceptof elasticity of demand has a very
wellas formulationof suitable economic policies.

PRICE ELASTICITYOF DEMAND

indicates the degree of responsitiveness
As mentionedabove, price elasticity of demand
other factors such as consumers'
Ofquantitydemandedof a good to the change in its price, are held constant. Precisely,
pricesof related commodities that determine demandchange in quantity demanded
Priceelasticityofdemand is defined as the ratio of the percentage
cofacommodity to a given percentage change in price. Thus
demanded
Percentage change in quantity
Percentage change in price
price of eggs causes its quantity demanded to fall
For example, suppose 5 per cent rise in
by10 per cent, we calculate price elasticity of demand for eggs as
 278 Advanced Economic Theory

rest
Price elasticity of demand 5
Strictly speaking, since as price of a commodity rises, its quantity demanded falls
should put positive sign before5
should put negative sign before 10 and since price rises. we
then we obtain the value of price elasticity as
-10
Price elasticityof demand ——
+5
-2

Thus, we get -2 as the price elasticityof demand. For the same changes in priceand
quantity demanded, we will get the same value of price elasticity of demand if price falls by5
percent and quantity demanded rises by 10 percent. In this case we have

-5
However,it may be noted that a convention has been adopted in economics that price
elasticity be expressed with a positive sign despite the fact that change in price and change in
quantity demanded are inversely related to each other. This is because we are interestedin
measuring the magnitude of responsiveness of quantity demanded of a good to changes in its
price.
It follows from the above definition of price elasticity of demand that when the percentage
change in quantity demanded a commodity is greater than the percentage change in pricethat
brought it about, price elasticityof demand (ep)will be greater than one and in this case
demand is said to be elastic. On the other hand, when a given prercentage change in priceof
a commodity leads to a smaller percentage change in quantity demanded, elasticity will be less
than one and demand in this case is said to be inelastic. Further, when the percentage change
in quantity demanded of a commodity is equal to the percentage change in price that caused
it, price elasticity is equal to one. Thus. in case of elastic demand, a given percentage change

x O x
Quantity Quantity
Fig. 14.1. Elastic Demand Fig. 14.2. Inelastic Demand
in price causes quite a large change in quantitydemanded.And in case of inelastic demand'a
given percentage change in price brings about a very small change in quantity demandedOfa
commodity.
It is a matter of common knowledge and observation that there is a considerable difference
between different goods in regard to the magnitude of response of demand to the changes in
 Elasticity of Demand 281
The dernand for some goods is more
In terminology of economics, we responsive to the changes in price than those for
would say that demand for some goods is more
elastic than those for the others or the price elasticity of demand of some goods is greater
than of the others. Marshalll who introduced the concept
remarksthat the elasticity or responsiveness of elasticity into economic
of demand in a market is great or small
accordingas the amount demanded increases much or little for a given fall in price, and
diminishesmuch or little for a given rise in price. This be clear from Figures 14. I and 14.2
whichrespresentt.J.'0demand curves. For a given fall in price, from
OP to OP', increase in
quantitydemandedis much greater in Figure 14.1 than in Figure 14.2. Therefore, demand in
Figure14.1 is more elastic than the demand in Figure in 14.2 for a given fall in price for the
of dernand curves considerd Demand for the good represented in Fig. 14.1 is generally
be elastic and the demand for the goods in Fig. 14.2 to be inelastic.
saidto
It should, however, be noted-thatterms-elasticand.inela$ic_demand
are used in the
relative sense* In other words, elasticity is a matter of degree only. Demand for some goods is
onjymore or lessglasticthan others. Thus, when we say that demand for a good is elastiC, we
mean that the demand for it is relatively more élastic. -Likewise;Ävhen we say
that demand
for a goods is inelastic, we Q_notmean that its demand is absolutelyinelastic but only that it
is relativelyless elastic, In economic theory, elastic and inelasticdemandshave come to acquire
precise meanings. Demand for a goods is said to be elastic if price elasticity of demand for it
is greater than one-Similarlyahedemand fora goods is called inelastic if price elasticity_of
demandfor it is less than one, PricegIasticitYQfdemand equal to one, or in other words, unit
elasticity_ofdeffård thereforerepresents thedividing line between elastic and inelastic demands.
It will now be clear that by inelastic demand we do not mean perfectly inelastic but only that
priceelasticityof demand is less than unity, and by elastic demand we do not mean absolutely
elasticbut that price elasticity of demand is greater than one.
Thus,
Elastic demand
Inelastic dernand •
Unitary elastic demand : e 1
PriceElasticity of Demand for Different (kxxis Varies a Good Deal
As said goods shove'great variation in respect of elasticityof demand i.e., their
responsivenessto changes in price. Some goods like common salt, wheat and rice are very
unresponsiveto changes in their prices. The demand for common salt remains practically the
samefor a small rise or fall in its price. Therefore, demand for common salt is said to be
'inelastic'.Demand for goods Ijce televisions, refrigeratorsetc., is elastic, since changes in
their prices bring about large changes in their quantity demanded. We shall explain later at
lengththose factors which are responsible for the differences in elasticity of demand of various
goods.It will suffice here to say that the main reason for differences in elasticity of demand is
thepossibility of substitution i.e., the presence or absence ofcompeting substitues. The greater
the be found for a commodityorwithUhiChit Canbe 'Obstituted
COF6ther greater will be the price elasticity of demand of that commoditsc
Goods are demanded because they satisfy some particular wants and in general wants
can be satisfied in a variety of alternative ways. For instance, the want for entertainment can
begratifid by having television set, or by possessing a gramophone, or by going to cinemas
or by visiting theatres. If the price of a television set falls, the quantity demanded of television

AYredMarshagsPrinc:ples of Economics. 8th Edition. Vol 2

 Theory
282 Advan€ed Economic
greatly since fall in the price of television will induce some people to buy
sets willrise or visitingcinemas and theatres. "Ibus the demand fra
of having gramophones
in place demand will greatly rise because it
if price of 'Lux' falls, its will be
is elastic. Likewise, Nirma etc. On the
other varieties of soap such as Jai, Hamam, Godrej,
for goods like common salt is inelastic. The demand for
demand for a necessary
since it satisfiesa basic human want and no substitutes for it are available p
inelastic
the same quantity of salt whether it becomes slightly cheaper
wouldconsume almost
than before.
Demand
PerfectlyInelastic and Perfectly Elastic
elasticity of demand. First extreme
We will now explain the two extreme cases of price
in Fig. 14.3. In this case changes
situationis of perfectly inelastic demand which is depicted
price of a commoditydoes not affect the quantity demand of the commodity at all. In
perfectlyinelasticdemand, demand curve is a vertical straight line as shown in Fig. 14.3.
will be seen from this figure, whatever the price the quantity demanded of the
remains unchanged at OQ. An approximate example of perfectly inelasticdernar;4 is
demand of acute diabetic patient for insulin. He has to get the prescribed doze of insulinper
Géü-whatever its price.

8
D

x x
Quantity Quantity
Fig. 14.3. Perfectly Inelastic Demand (e = O) Fig. 14.4. Perfectly Elastic Demand e; =
The second extreme situaiton is of perfectly elastic demand in which case demand curve
is a horizontal straight line as shown in Fig. 14.4. This horizontal demand curve for a product
implies that a small reduction in price would cause the buyers to increase the quantity demarded
from zero to arthey wanted. On the other hand, a small rise in price of the product will cause
to'Witch complefély away from the product so that its quantity demanded%lls to
zero. We will see in later chapters that perfectly elastic demand curve is found for the product
bf-an individual firm working under perfect competition. Products of different firms working
under perfect competition are completely identical. If any perfectly competitive firm raises the
price of its product, it would lose all its customers who would switch over to other firms andif
it reduces its price somewhat it would get all the customers to buy the product from it.

MEASUREMENTOF PRICE ELASTICITY

As said above, price elasticity of demand expresses the response
of relative change in
quantity demanded of a good to relative changes in its price, given the
consumer's income, his
tastes and prices of all other goods. Thus price elasticity means the degree of responsiveness
or sensitiveness of quantity demanded of a good to a change in its
price. An important method
 Elasticity of Demand 283
elasticity of demand is the percentage method which we explain below.
tomeasureprice
price elasticitycan be precisely measured by dividing the percentage change in quantity
demanded by the given percentage change in price that caused it. Thus we can measure price
using the following formula:
elasticityby
Percentage change in quantity demanded
Price Elasticity
Percentage change in price

Change in quantity demanded / Quantity demanded

Change in price [Price
or, in symbolic terms
Aq/q _ Aq Ap

Aqx p
q Ap
Aq p
Ap q
where e stands for price elastictity
q stands for quantity demanded
p stands for price
2
A stands for infinitesimal small change
change in
Mathematicallyspeaking, price elasticity of demand (ep) is negative, since the
price falls, quantity
quantitydemandedis in opposite direction to the change in price; when
understanding the magnitude
demandedrises and vice versa. But for the sake of convenience in take
ignore the negative sign and
of response of quantity demanded to the change in price we
if 2% change in price leads to 4%
intoaccount only the numerical value of the elasticity. Thus, the above
good B, then
changein quantitydemanded of good A and 8% change in that of
equal to 2 acv' of good B
formulaof elasticitywill give the value of price elasticityof good A good
changes much more that of
equalto 4. It indicates that the quantity demanded of good B
A in responseto a given change in price.
Midpoint Method of Calculadng Percentage Changes
percentage or proportionate
When we calculate the price elasticity of demand through
as the base for calculating percent
methodwe face a problem whether to use the initial price
calculating the percent change in quantity
changein price and initial quantity as the base for price of a
For example, suppose
demandedin response to a given percent change in price. quantity demanded falls from
result, the
commodityrises from Rs. 4 to Rs. 6 per unit and as a
the base for change in price, then change
120 units to 80 units. If we take initial price Rs. 4 as
1
price 100= - x 100= 50 And
in price by Rs. 2 amounts to 50 percent change in 44 2
calculating percent change in quantity demanded,
taking initial quantity 120 units as the base for
1 100 = 33.3
120-80 x 100 = -x
thenthere is 33.3 percent change in quantity demanded 120 3
284 Advanced E«s.nomtcTheory
ms of demand as
svt prfe elæsttcitv
33 -000
ep a —
50
Let us now rexvrse the ditvction. Suppose the price of the commodity falls from 6
4 per taut. and as a result quantitv demanded increases from 80 units to 120 units, then
t&kNNinitul 6 as the base for calculating percentage change in price, then there is 33 3

cent change in price and taking 80 units as the basefor

O
pen-entage change in quantity, then the quantity demanded rises by 50 percent
40 50
100 — 100 = 50 Thus, we will now get —1.5as the price
33.3 elasticity
of It thetvfore followsthat for the same absolute change in price and absolutechange
in .k•ntity demanded get different values of price elasticity of demand if we use 4
or
6 as tiw base for calculating percentage change in price and 120 units or 80 units as the
base for calculatingpercentage change in quantity demanded. To avoid thisproblernwe use
midB'i_nt method for calculating the percentage changes in price and quantity demanded In
tt'Æporntmeth.xå calculatethe percentage change in price or quantity demanded bytaking
midpoint of the initial and final values of price and quantity demanded respectivelyasthe
base, Thus. in our above example. midpoint (or, in other words, average) of prices of 4 and

6 is = 5 and midpoint (or average) of quantities demanded is 80 + 120 = 100. Using

2 2
6—4
this midpointmethod, the percentage change in price is —x 100 = 4() and percentage
5

change in quantity demanded is

120- so x
100 = 40. With ihese percentage changesin
100
price and quantitydemandedprice of elasticityof demand will be

40
40
It sh0QÆbe carefullynotedthatfor large changes in price, we
must use midpoint
oj demand. Ifchange in price is wry small, thenwe
can use initial price and initial quantity
It stands for initial price and P2 for the new price and
qi for the initial quantity andq2
for the new'quantity, then midpoint formula for calculating
price elasticity of demand (ep)can

Q -m) + PEPI
qi+Q2 PI
2 2

+ Ap
2
 Elasticityof Demand 287
(b)TotalRevenue before reduction in price •t 2000 x 150 •s
Totalrevenueafter price reduction 2070 x 142.5 2,94,975
Thuswithreduction in price his total revenue has decreased.
Price Elasticity from a Demand Function
Finding
Lineardemandfunction for a commodity is of the following form

whereQ standsfor the quantity demanded and P for price of the commodity, a and b are
constants.
Notethatb represents the slope of the demand function which is negative and shows the

ratioofchangein quantity to a change in price, that is,

AQ p
Now,

Writingb for j—- we have

Withthe expression of above equation (ii) we can measure price elasticity from a given
demandfunction.Let us take a numerical example.
Supposewe are given the following demand function for milk in the city of Delhi.
Q- 720-25 P
Q is in thousands of litres. It is required to find out the price elasticity at price of 15 per
litre.

b or — in the given demand function is 25. To obtain price elasticity we have first to
thequantitydemanded at the given price of
calculate 15 per litre. Substituting 15 for P in
thegivendemandfunction, we have
Q- 720-25x 15
Q = 720 - 375 = 345
Now,substitutingP 15, Q = 345 and b = 25 in the elasticity expression of equation (ii)
alongwe have

ep=b — 15
= 1.08
Q 345
Thuspriceelasticityat price 15 per litre is 1.08 and quantity demanded of milk is equal
to345 thousand
litres
PriceElasticityof Demand and Changes in Total Expenditure
It is Oftenuseful to know what happens to total expenditure made by the consumers on a
whenits price changes. In Figure 14.5 a demand curve DD of a good is shown. When
288 Advanced Economic Theory
the price of good is OP, its quantitydemandedis OQ. Since the totalexpenditureis
multiplied by the quantity of the good purchased, therefore
Consumer's total expenditure
= OP x0Q = areaOQRP
Now, whether the total expenditure rises or falls or remains the same with the cha
nge
the price of the good depends upon the price elasticity of demand. The total expenditure io
an important relationship with the price elasticity of demand and this relationship is of great
significance in the theory of price. The following is the relationship between changes in
expenditure and price elasticity of demand.
The relationship between price elasticity of
demand for goods and total expenditure or outlay
made on it is of great significance because with
this knowledge of
of the goods can estimate how his total revenue
•sein_theprice of the
goods. As seen a ove, the price elasticity of R'
demand measures the ratio of proportionate
change in quantity demanded to the proportionate
change in price. That is, ignoring signs,
e = AQ/Q/AP/Por % AQ/% AP.
If price elasticity of demand is greater than
one, then ignoring the signs, %AQ > % AP. On x
Quantity
the other hand, if price elasticity of demandis
less than one, % AQ < % AP. And if price elasticity
equals one or, in other words, demand is unitary Fig. 14.5. Changes in Price and Total
elastic, % AQ = % AP. For the sake of convenience, Expenditure
we write the results of this relationship in Table 14.1.
Table 14.1 Relationship Between Price Elasticity (ep) and Total Expenditure (TE)
Price change Elasticity greater than one elasticity less than one Elasticity equal to one

Price falls TE increases TE decreases No change inTE

Price rises TE decreases TE increases No change inTE

Proof of the Relation Between Price Elasticity and Total Expenditure

We can@iaphically prove the above-mentioned relationship between price elasticityOf
demand and the total expenditure. Consider Figure. 14.6. Suppose the price of a commodity
falls from P to PI and in the response to it the quantity demanded increases from Q to
Since the total expenditure on a good equals the quantity demanded (Q) multiplied by the price
of the good (P), that is, TE = P.Q, it will be seen from the diagram that at price OPthe total
expenditure equals the area of the rectangle OPRQ and with the fall in price of the good the
total expenditure equals OPI TQI. Whereas the fall in price (—AP) exerts a downward pressure
on the total expenditure causing a decline in expenditure equal to AP.Q. The increase in the
quantity demanded caused by it (+ AQ) exerts an upward pressure on the total expenditUre
causing a gain in expenditure equal to AQP. If net total expenditure increases as price falls'
then, as will be seen from Figure 14.6, the gain in expenditure (+ AQP) measured by the area
 Elasticityof Demand 289
of the rectangle QLTQI must be greater than the
decline in expenditure AP Q) as measuredby
-APO the area of the rectangle PRLPI. Thus, if with the
fall in price from P to PI, the total expenditure
increases, we have
AQP > APQ.
Rearranging we have

+ AOP
APQ

Q
x AQ.p
Quantity Now, as seen above, measuresthe

fig. 14.6. When total expenditure increases price elasticity of demand. It follows therefore that
mth the fall in price, e is greater if the total expenditure increases
than one AQP
>1
APQ ¯ ep
It is thusproved that if the total expenditure on a commodity increases resulting from a
elasticity of demand is greater than one.
fallin its price, the price
Likewise,we can show that if with the fall in price of a good the total expenditureon it
declines, price elasticity will be less than one. Consider Figure14.7 where it will be seen that
decline in
withthefallin price from P to PI the total net expenditure decreases because as the
expenditure (—APQ) due to fall in price (—AP) exceeds the gain in expenditure (+ AQP) due to
theincreasein quantity demanded (+ AQ) caused by it.
Thus,when total expenditure (TE) decreases with the fall in price we have
AQP < APQ
Rearrangingwe have
AQP

AQP

-APO

Q 01 x
x Quantity
Quantity
F19.14.7.When mth the tall in pnce of a Fig.14.8. When Withthe tall in price Ota
the same,
commodity total expenditure decreases, commodity, total expenditure remains
to unity
Onceelasticityof demand is less than one price elasticity of demand IS equal
290 Advanced Economic Theory
fall in price from OP to Op
Similarly, as willbe seen from Figure 14.8, with the
expenditure (+ AQP)
expenditure on the good remains constant as the gain in
expenditure (-APQ) due to the fallin
increase in quantity demanded equals the decline in
Thus, with the fall in price, constant total expenditure implies
AQP - APC)

AQP
APC)

As mentioned above, from the point of view of sellers and producers of goods the
between price elasticity and total expenditure is of great importance. This relationship deterrjinq
whether or not the seller's revenue or earnings would increase with the rise and fallinrjrirg
Total expenditure on a goods made by the consumers is revenue for the sellers. It is
from the above relationship, that if a seller of a product plans to cut the price of hisproduct
the total expenditure on it and therefore the total revenue of the seller willincrease onlyif
demand for its product is elastic (e > 1) and his total revenue would decrease if the
for its product is inelastic(e < I). bn the other hand, if the firm plans to raise the price
product in a bid to increase its total revenue with the increase in its price, his total revenue
increase if the demand for its product is inelastic(e < 1).

MEASUREMENT OF PRICE ELASTICITY OF DEMAND AT

A POINT ON A DEMAND CURVE
Let a straight line demand curve DD ' is given and it is required to measure price elasticity
at a point R on this demand curve. It will be seen from Fig. 14.9 that corresponding to point
R on the demand curve DD price is OP and quantitydemanded at it is OQ.
The measure of price elasticity of demand is given by :
AQ p

The first term in this formula, namely, — is the reciprocal of the slope of the demand

curve DD (Note that the slope of the demand curve DD ' is equal to — which remains

constant all along the straight-line demand curve). The second term in the above point elasticity
formula is the original price (P ) divided by the original quantity (Q). Thus, at point R, on the
demand curve DD '

slope •Q
It will be seen from Fig. 14.9 that at point R, original price P = OP and original quantity

Q —OQ. Further, slope of the demand curve DD', is —-

AQ PR
Substituting these values in the above formula we have
 Elasticityof Demanå

PR

Aglanceat Figure 14.9 reveals that PR

willtherefore cancel out in the
OQandthey
aboveexpression.

Therefore, ...(1)
x
Measuringprice elasticity by taking the Quantity
ratioofthesedistanceson the vertical axis, that Fig. 14.9. Measuring Price Elasticity
at a point
on a Straight-LineDemand Curve
• , -—-is called vertical axis formula.

In a right-angledtriangle ODD PR is parallel to OD'.

Therefore,
e
OP RD'

RD' is the lower segment of the demand curve DIY at

point R and RD is its upper
segment.Therefore,

RD' lower segment

e
RD upper segment
Measuringprice elasticity at a point on the demand curve by measuring the
ratio of the
distancesof lower segment and upper segment is a popular method of measuring
point price
elasticityon a demand curve.
Measuring price elasticy on a non-linear demand curve. If the demand curveis not a
straight
linelike DD' in Fig. 14.9 but is, as usual, a non-linear curve, then how to measure
priceelasticityat a given point on it? For instance, how price elasticityat point R on the
demandcurve DD in Fig. 14.10 is to be found. In order to measure price elasticity in this case,
wehaveto draw a tangent TT at the given point R on the demandcurve DD ' and then

measure
price elasticity by finding out the value of

Ona linear demand curve price elasticity varies from zero to infinity. Nowagain,
thestraight-linedemand curve DD ' (Fig. 14.11). If point R lies exactly at the middle of
straight-linedemand curve DD then the distance RD will be equal to the distance RD '.

nierefore,elasticity which is equal to will be equal to one at the middle point of the
RD
Straight-line
demand curve. Suppose a point S lies above the middle point on the straight-line
curve DD '. It is obvious that the distance SD ' is greater than the distance SD and price
292 Advanced Economic Theory

x CY

Ouantity Quantity Demanded

Fig. 14.10. Measunng Pnce Elasticity at a Fig.14.11. On a linear demand curve pace
Pant on a Non-Linear Demand Cutve elasticity varies from infinityto
zero

elasticity, which is equal to at point S, will bemore than one. Similarly, at any otherpoint
SD
which lies above the middle point on the straight-line demand curve, price elasticitywillbe
greater than unity. Moreover, price elasticitywill go on increasing as we move furthertowards
point D and at point D price elasticity will be equal infinity. This is because price elasticity
is
lower segment
equal to and as we move towards D the lower segment will go on increasing
upper segment
while the upper segment will become smaller and smaller. Therefore, as we move towardsD
on the demand curve, the price elasticity will be increasing. At point D, the lower segmentwill
be equal to the whole DD ', and the upper segment will be zero. Therefore,

DIY
Price elasticity at point D on the demand curve DD ' = = infinity.
0
Now, suppose a point L lies below the middle point on the linear demand curve DD ' in
Fig. 14.11. In this case, the lower segment LD ' will be smaller than the upper segmentLD

and therefore price elasticity at point L which is equal to will be less than one.
Moreover,price elasticity will go on decreasing as we move towards point D '. This is
becaug whereas lower segment will become smaller and smaller, the upper one will be increasing
as we move towards point D At point D ' the price elasticity will be zero, since at D' thelower
segment will be equal to zero and the upper one equal to the whole DD At point D '
 Elasticityof Demand 293

price ElasticityVaries at Different Points on a Non-linear Demand Curve

From above it is clear that price elasticity at different points on a given demand curve (or,
in other words. price elasticity at different prices,)is different. This is not only true for a straight-
linedemandcurve but also for a non-linear demand curve. Take, for instance, demand curve
in fig. 14.12. As explained above, price elasticity at point R on the demand curve DD will
drawing a tangent to this point.
be foundout by
R will be Since distance
Thus elasticity at
price elasticity at point
RT' is greater than RT,
one. How exactly it is equal
R willbe more than
value which is obtained
to willbe given by actual
fromdividingRT ' by RT. Likewise, price
S]'
elasticityat point S will be given by
BecauseSJ ' is smaller than SJ, elasticity point
at S willbe less than one. Again,how exactly it x
is, equalto will be found from actually dividing Quantity
SJ ' by SJ. It is thus evident that elasticity at
point S is less than that at point R on the Fig•14.12.Priceelasticitydeclinesas we move
down on a demand curve.
demand curve DD. Similarly, price elasticity at
other points of the demand curves DD will be
found to be different.
Comparing Price Elasdcity at a Given Price on the Two Demand Curves with

Having explained the measurement of price elasticity on a demand curve we will now
explain how to compare price elasticity on two demand curves.
Let us take the case of two demand curves with different slopes starting from a given
pointon the Y-axis. This case is illustrated in Fig. 14.13 where two demand curves DA and
DB which have different slopes but are starting from the same point D on the Y -axis Slope of
demandcurve DB is less than that of DA. Now, it can be proved that at any given price the
priceelasticityon these two demand curves would be the same. If price is OP, then according
to demand curve DA, quantity OL of the good is demanded and according to demand curve
DB, quantityOH of the good is demanded . Thus, at price OP the corresponding points on the
twodemand curves are E and F respectively. We know that price elasticity at a point on the
lower segment demand at point E
demandcurve is equal to upper segment Therefore, the price elasticityof

on the demand curve DA is equal to ED and the price elasticityof demand at

point F on the

demandcurve DB is equal to
triangle in which PE is parallel ot OA.
Now, take triangle ODA which is a right-angled

It follows that in it, is equal to Thus, the price elasticityat point E on the
ED
 (71

294 Advanced Economic Theory

demand curve DA is equal to

Now, in the right-angledtriangleODB,

is
PF is parallel to OB. Therefore, in it

demand
equal to — . Thus, price elasticity of
also
at point F on the demand curve DB is
price
equal to — From above it is clear that Quantity

elasticity of demand on points E and F on Price Elasticity on the

the two demand curves respectivelyis equal Fig. 14.13. Comparing
TwoDemand Curves with
DifferentSlopes
to — , thatis,price elasticities of demand
these two demand curves are different
at rx»ints E and Fare equal though the slorxs of
same thing as slope. Therefore,price
It thereforefollows that price elasticity is not the their slopes alone.
by considering
elasticity on two demand curves should not be compared

DETERMINANTSOF PRICE ELASTICITY OF DEMAND

We have explained above the concept of price elasticity of demand and also how it is
measured. Now an important questionis what are the factors which determine whetherthe
demand for a goods is elastic or inelastic. The following are the main factors which determine
price elasticity of demand for a commodity.
The Availabilty of Substitutes. Of all the factorsdetermining price elasticity of demand
the availability of the number and kinds of substiutes for a commodity is the ryp$_imporian
factor. If for a commodity close substitutes are available, its demand tends to be elastic. If price
of such a commodity goes up, the people will shift to its close substitutes and as a result the
demand for that commodity will greatly decline. The greater the possibility of substitution, the
greater the price elasticityof demand for it. If for a commodity good, substitutes are not
available, people will have to buy it even when its price rises, and therefore its demand would i
tend to be inelastic.
For instance, if price of Coca Cola were to increase sharply,
many consumers would turn
to other kind of cold drinks, and as a result,the quantity
demanded of Coca Cola will decline
very much. On the other hand, if price of Coca Cola
falls, many consumers will change from
other cold drinks to Coca Cola. Thus, the demand
for Coca Cola is elastic. It is the availability
of close substitutesthat makes the consumers
senstive to the changes in price of
and this makes the demand for Coca Cola Coca Cola
elastic. Likewise, demand for
inelastic because good substitutesfor common saltis
common salt are not
salt rises slightly, people would consume available. If the price of common
almost the same quantity
since good substitutesare not available. of common salt as before
The demand for
people spend a very littlepart of common salt is inelastic also because
their income on it and even if
negligible difference in their budget its price rises, it makes only
allocation for common
The Proportion of Consumer's salt.
elasticityof demandis how Income spent.
much it accounts for Another important determinant Ofthe
in consumer's
Coco budget. In other words the
 Elasticity of Demand 295
of consumer's income spent on a
particular commodity also influences price elasticity
for it. The greater the proportion
of income spent on a commodityßhg gyeater will
be its price elasticity of demand,
and vice versa. The demand]or common salt, soap,
Other goods tends to be
highlyinelastic because the households spend only
a of their income on each of them. When
price of such a commodity rises, it will not
difference in consumers' budget
and therefore they willcontinue to buy almost the
(bnntityof that commodity and, therefore,
demand for them will be inelastic. On the
otherhard, demand for cloth in a country like India
tends to be elastic since households
a good part of their income on clothing. If price of cloth falls,
the budgetof many households and therefore this willtend it will mean great saving
to increase the quantity demanded
oi cloth, On the other hand, if price of cloth rises,
many households will not afford to buy
as quantityof cloth as before, and therefore, the
quantity demanded of cloth will fall.
The Number of Uses of a Commodity.
The greater the number of uses to which a
can be put, the greater will be its price
elasticity of demand. If price of a commodity
several uses is very high, its demand will be small
and it willbe put to the most important
ard if price of such a commodity falls it wil be put
to less importantuses also and
consequentlyits quantity demanded will rise significantly. To
illustrate, milk has several uses. If
itspricerises to a very high level, it will be used only for
essential purposes such as feeding the
chiEren and sick persons. If price of milk falls, it would be
devoted to other uses such as
preparationof curd, cream, ghee and sweets. Therefore, the
demand for milk tends to be

Complementarity Between Goods. Complementarity between goods

or joint demand
forgoods also affects the price elasticity of demand. Households are
generally less sensitive to
ffe changes in prices of goods that are complementary with each other or which are
jointly
usedas compared to those goods which have independent demand or used alone. For
example,
for naming of automobiles, besides petrol, lubricating oil is also used. Now, if price
of
Lbricatingoil goes up, it will mean a very small increase in the total cost of running the
auromobile,since the use of oil is much less as compared to other things such as petrol. Thus,
demand for lubricating oil tends to be inelastic. Similarly, the demand for common salt is
inelastic,partly because consumers do not use it alone but along with other things.
It is worth mentioning here that for assessing elasticty of demand for a commodity all the
abovefrtree factors must be taken into account. The three factors mentioned above may
reinforceeach other in determining the elasticity of demand for a commodity or they may
operateagainst each other. The elasticity of demand for a commoditywill be the_ngtresult of
al the for
—----.--.--.-.--.gesuorking-on it •
Time and Elasticity. The element of time also influences the elasticityof demand for a
Demand tends to be more elastic if the time involvedis long. This is because
consumerscan substitute goods in the long run. In the short run, substitution of one commodity
by'another is not so easy. The longer the period of time, the greater is the ease with which
bothconsurners and businessmen can substitute one commodity for another. For instance, if
pru of fuel oil rises, it may be difficult to substitute fuel oil by other types of fuels such as coal
or cooking gas. But, given sufficient time, people will make adjustments and use coal or
cookinggas instead of the fuel oil whose price has risen. Likewise, when the business firms
findthat the price of a certain material has risen, then it may not be possiblefor them to
substitutethat material by some other relatively cheaper one. But with the passage of time
they can undertake research to find substitute material and can redesign the product or modify
the machinery employed in the production of a commodity so as to economize in the use of
dearer material. Therefore, given the time, they can substitute the material whose price
296 Advanced Economic Theory
in the long than in the short
has risen. We thus see that demand is generallymore elastic

DEMAND
CROSS ELASTICITYOF
goods are so related to each other that when price Of any of
Very often demand for tW'0 changes, when its own price remains the
goods also
them changes, the demand for the other
of change in the demand for one good •
same. Therefore, the degree of responsiveness the corss elasticity-of-demand
of
another good represents
response to change tn priceof
goods fo€QKéother.

Dix
O x
O M2 Ml x
Quantity

Goods X (b) Demand for Goods Y

(a) Demand for
Substitutes Goods
Fig. 14.14. Demand Relations Between Two
by Figure 14.14 where demand
The concept of cross elasticity of demand is illustrated
of two goods X and Y are given. Initially, the price of goods Y is OPI at which OMI
curves
quantity of it is demanded.
while price of goods X
Now suppose that the price of goods Y falls from OPI to OP2,
from OPI to OP2, its
remainsconstantat OP. As a consequenceof fall in price of good Y
curve Dx Dx for good X,
quantity demandedrises from OQI to OQ2. In drawing the demand
same. Now that the
it is assumed that the prices of other goods (Including good Y) remains the
of the fall in price
price of good Y has fallen and as Yis a substitutefor good X, then as a result
demand for
of good Y from OPI to OP2, demand curve of good X will shift to the left, that is,
good X will decrease.This is because,as we have seen in the chapter on cardinal utility
es
analysis, as the quantityof a good increases, the marginal utility of its substitute good declin
all
and therefore the entire marginal utility curve of the substitutegood shifts to the left. As sh
ve
be seen from the Figure 14.14 that as a result of the fall in price of good Y, the demand cur
of good X shifts from DxDx to the dotted position Dx'Dx' so that now at price OP less quantity
OM2 of good X is demanded; MIM2 of good X has been substituted by QIQ2, quantity of good

It should be noted that if good X instead of being substitute is complement of good Y '
then the fall in price of good Y and resultant increase in its quantity demanded would have
caused the increase in the demand for good X and as a result the entire demand curve Of good
X, instead of shifting to the left, would have shifted to the right. This is because, as has been i
explained in the chapter on cardinal utility analysis, when the price of a good falls and
consequently its quantity demanded increases, the marginal utility of its complements inc reases
and therefore the entire demand curve of the good X would shift to the right. With the righ tward
 Elasticityof Demand 297
shiftofthedemand curve of goods X, greater
quantity of it would be
be noted again that in the concept of demanded at price OP. It
one, cross elasticity of
in price of the quantity demanded
of another good
demand, in response to the
Whenthe quantity demanded of good changes.
X rises as a result
the of cross elasticity of demand of of the fall in the price of good Y,
X for Y will be equal
demandedof goods X in response to to the relativechange in the
a given relative
Therefore,
change in the price of good Y.

Proportionate change in the

quantity
demanded of X
Coefficientof cross elasticity of =
demandof X for Y Proportionate change in the price
of good Y
Aqx

or, ec A py
Apy qx Py

Aqx py

py

whereec stands for cross elasticity of demand of X for Y

qx stands for the original quantity demanded of good X
Aqx stands for change in quantity demanded of good X
p standsfor the original price of good Y
Ap standsfor a small change in the price of good Y
Whenchange in price is large, we shoulduse midpointmethodfor estimatingcross
elasticityof demand. We can write midpoint formula for measuring cross elasticity
of demand as

qx2 ¯ qxl p Y2—pyl

e
qx2 + qxl PY2+ p
2 2
NarnericalProbLrns
Problem I. Ifprice of coffee rises from Rs. 45 per pack to Rs. 55 per pack of 250 grams
andas a result the consumers demand for tea increases from 600 packs to 800 packs of 250
grams,then find the cross elasticty of demand of tea for coffee.
Solution. We use midpoint method to estimate cross elasticityof demand.
Change in quantity demanded of tea qt2 -- qtl 800 600
Change in price of Coffee —PC2 -- PCI —55 45
SUbstitutingthe values of the various variables in the cross elasticity formula we have
298 Advanced Economic Theory

800-600 + 55-45 = 200 50 10

Gross elasticityOfdemand 800+600 55+45 700 10 7
2 2
demand function for coffee in terms
Problem 2. Suppose the following when price of tea rises from 50
the cross elasticity of demand
tea is given. Find out
250 grams pack to 55 per 25() grams pack.
QC- 100 + 2.5%
coffee in terms of packs of 250 grams p
where QC is the quantity demand of
the price of tea per 250 grams pack.
of Pt shows that rise in price of tea
Solution. The positive sign of the coefficient
This implies that tea and coffee are
an increase in quantity demanded of coffee.

coefficient
dQc 25
The demand function equation implies that

tea and coffee, we firstfind

In order to determine cross elasticity of demand between
quantitydemandedof coffee when price of tea is 50 per 250 grams pack. Thus,
100 + 2.5 X 50 - 225
dQc pt
Cross elasticity, dPt QC

50 125 = 0.51.
= 2.5 x —
225 - 225
Cross Elasticity of Demand : Substitutes and Complements
As we have seen in the example of tea and coffee above, when two goods are substitute
of each other, then as a result of the rise in price of one good, the quantity demandedof
other good increases. Therefore, the cross elasticity of demand between the two substa
goods is positive, that is, in response to the rise in price of one good, the demand for the0th*
good rises. Substitute goods are also known as On the other hand,wha
the two goods are complementary with each other such as bread and butter, tea and milk,et..
the rise in price of one good brings about the decrease in demand for the other.Therefn
the cross elasticity of demand between the two complementary goods is negative. THA
according to the classification based on the concept of crrxs elasticity of demand,
X and Y are substitutes or complements according as the cross elasticity
ofdeÄ
positive or negative. However, these definitions of substitute and complementary goodsb
terms of cross elasticityof demand are not very satisfactory. While goods between
cross elasticity of demand is positive can be called substitutes, but the goods between
cross elasticity is negative are not always complements. This is because positive cross e
is also found when income effect of the price change is very strong.
Take two goods X and Y where the demand for good X is inelastic. Suppose the price
good X falls and as a result real income of the consumer increases. Since the demand for
X is inelastic, the less moeny would now be spent on good X when its price has fallen•In
way, a good amount of money income would now be released from good X which
spent on good Y. Thus, the income effect of the fall in price of X on the demand for good
will be very large and, as a result, the quantity demanded of good Y will increase (thede
 Elasticityof Demand 299
forgood Y willshift to the right). We thus
see that thefall in price of good X has
in the increase in demand for
good Y and therefore the cross elasticityand demand
ofgoodY for good X is negative. But this negative cross
elasticityof demand of Y for X is not
dueto thecomplementary relationship between the two but due to
red to the substitution effect on the the strong incomegffect as
demand for good Y produced
by the fall in price of
This can be easily understood from the aid
of indifferencecurve diagram (Figure 14.15).
Withgiven prices of goods X and Y and a given money
is income as representedby the budget
line the consumer in equilibrium at point Q on
indifferencecurve ICI, where he is
purchasingOMI of good X and ONI of good Y. Now, suppose
that the price of good X falls so
thatthebudgetline switches to the right to the position PL'. With
PL' as the budget line, the
consumeris in equilibrium at point R at which he is buying
more of good X as well as more of
goodY. This increase in the demand for good Y has come about as
a result of stronger income
effecton Y as compared to substitution effect on V Thus, in this
case of strong income effect
forgoodY, the quantity demanded of good Y increases as a resultof the fall in
price of good
X,and therefore the cross elasticity between the two is negative even
though they are not
complements.
We have explained above important case where the cross elasticity
between the two
goodsis negative even when they are not complements of each other. Thus, though the cross
betweenthe complements is negative, but negative cross elasticity, as we have
elasticity
sæn above, cannot always be associated with complements, sincenegativecrosselasticity
is alsoassociatedwith relatively powerful income effect. Thus, Ryan writes, "While we shall
generallyfind that where the cross elasticity is negative, the goods would be regarded as
complemntary in everyday usage.... We may associate negative cross elasticitiesof demand
notonlywith complementarity but also with relativelystrong income effect.4
It wouldbe clear from the above analysis that cross elasticity approach to classify the
goodsas substitutesand complements is based upon the total price effect on the quantity
demanded of a good resulting from a change in another good's price without compensating
for the change in the level of real income, that is, without eliminating income effect. Thus, to
quoteFerguson, "the cross elasticity approach to commodity classification, directs attention to
thechange in quantity demanded resulting from a change in price without compensating for
thechangein the level of real income. The total effect of a price change is thus the criterion
usedin this classification scheme". 5
It is because of this inherent shortcoming that cross elasticity approach to classify goods
as substitutesand complements leads to misleading conclusions regarding complementary
goods.Therefore„in his important work 'Value and Capital', Hicks pointed out that more

2 It should be noted that the income effect and substitution effect on good Y produced by the falt in
pnce of good X, work in the opposite direction. While the income effect on Y of the fall cytce ot
X tends to Increase the quantity demanded of Y, the substitution effect tends to the quant'ty
demandedof v This is because consumers would tend to substitue relatively cheaper good X tor
good v But it the income effect on Y is stronger, it would outweigh the substitubon effect
3. That tho two goods Y are not complements IS evident trom the shape ot thew indtterence
X and
curvesin Figure 14.15. As has been explained in the chapters on Indifference Curve Analysis ot
Demand, the shape Of the indifference curves of two complements is angular
4•W J L. Ryan Pnce Theory, Macmillan and Co. Ltd, London. 1959, p. 41,
5 CF Ferguson, Microeconomjc Theory, Richard C). irwjn Inc. Illinois, 1967
 300 Advatued llu•ovy
can be on basis
accurate classificationof substitutes
effect alone of the price chal after the it effecthas I

empirical level, it is very difficult to

substitution effect alone, since it is based on
individual's preference function about which
data ave not readily available. Thus,
according to Ferguson. a move accurate
classification can be obtained by analysing
the substituion effect alone. But while the
latter method is accurate. it is also
move difficult to utilize on an etnpivical level.
Thus in actual problems the older and less
precise method must usual! be used.o I le
further says, "On an empirical level the cross
elasticity approach is the only feasible
method of commodity classificationbecause CommodityX
market demand function can be computed Fig. 14.15.Ootnanci goods Y duo
while individualpwference function cannot ottoct of cha/
" to sttong01 incotno Poco
be from readily available data.
applied
Moreover. cross elasticity approach to commodity classification is very useful in
economic problems because in such problems we are generally interested in knowingthe
market relations among various commodities rather than the relation among commoditiesas
considered from the viewpoint of consumer preference functions."Thus the crossælasticity1
classification of commodity relations is the one most frequently encountered in applied studies.n7
The concept of cross elasticity of demand can be better understood with the aidof
indifference curve analysis. Three indifference curves diagrams (Figure 14.16, 14.17 and I
14.18) are drawn below in which the difference is found in the shapes of indifferencecurves.
As explainedin the chapter on indifferencecurves, the shapes of the indifferencecurves
between two commodities reflect the consumer's scale of preferences between two commodities..
With given prices of two goods and given income of the consumer, the budget line, to begin
with, is PI-I. Suppose, with the fall in price of good X, consumer's income and priceof Y
remaining the same, price line shifts to the position PL2. As a result of this fall in price of X in
Figure 14.16 the consumer buys more of good X and less of good Y. In other words, cross
elasticitybetween goods X and Y in Figure 14.16 is positive. It should be noted that in case Of
pc»iiivecross elasticity, price consumption curve slopes downwardasin figure14.16
Similarly, in Figure 14.17 with price line PI-I, the consumer is in equilibriumat point Q
on indifferencecurve ICI. As a resultof fall in price of X, price of Y and consumer's income
remaining the same, the budget line switches to the position PI-2 and consumer comes to be
in equilibriumpositionat R where he is buying greater quantity0M? of X but the same
quantity of good Y In other words, with the fall in price of X, the quantity demanded Of good
Y has not changed at all. Therefore, in this Figure 14.17 cross elasticity of demand betweenX
and Y is zero. It shouldbe noted that in case of zero cross elasticity of demand' price'i
consumption curve is a horizontal straight line, that is, it is parallel to the X-axis•

6. p 60
7, p 63
 %-PCC N,
PCC
IC2

CommodityX CommodityX

Fig. 14.16. Substitute Goods : ec is positive

NowconsiderFigure 14.18 where with the fall in price of good X and consequently
shiftingof the price line from PLI to PI-2, the consumer's equilibrium position shifts from Q to
R. It willbe seen from Figure14.18 that as a result of fall in price of X, consumer is buying
morenotonly of X but also of Y. In other words, fall in price of X has resultedin the inérease
inquantitydemanded of good Y. Therefore, the cross elasticity of demand between X and Y in
figure14.18 is negative. It should be noted that in case of negative cross elasticity of
demand,price consumption curve slojp.s upward.
It is worthmentioning here that through indifference curves analysis, we can only know
whether crosselasticityis negative, zero or positive, we cannot precisely measure the magnitude
of cross elasticity of demand.
The conceptof cross elasticity of demand is very important in economic theory The
and complementary goods, as we have seen above, are defined in terms of cross
substitutes
of demand. The goods between which cross elasticity Qf dpmand is positive_are
elasticity
knownas substitutegoods and the goods between whichcross_elasticity of demand is negative-
are complementary goods. Besides,
c ssificationof various ypes of market
structures
is made on the basis of cross
elasticityof demand. Triffen has employed
ce t of cross elastici o nd in
distinguishingthe various orms of markets,
Perfectcom tition is defined as that in
Whichthe cross elasticity of demand betwee
theproductsproduced b many firmsjnit_ii
infinite.
Monopoy is said to exist when a
Pr0dÜé@üproducesa-prodåaathe cross
elasticity
of whose product with any_9ther
Productis very 160JÄn fact, the pure or
absolutemonopoljå"ften defined as the X
Production
by Yinglepröducer
whosecross elasticity
of demand produce Fig. 14.18. Complementary Goods . ec IS
WitlanVOiherprodüctis zero. Monopolistic negative
302 Advanced Economic Theory
competition is said to prevail in the market when a large number of firms produce th
positive, that is, they are cl
products among which cross elasticityof demand is large and
substitutes of each other.
Decision Making
Importance of Cross Elasticity of Demand for Business
great importance in managerial decisir
The concept of cross elasticityof demand is of
Multiproduct firms often use this conceptto
making for formulating proper price strategy.
on the demand for other products.
measure the effect of change in price of one product
Vans, Maruti 800 and Maruti Esteem. Th
example, Maruti Udyog Ltd. produces Maruti
therefore cross elasticityof demand betw
products ave good substitutesof each other and
to lower the price of Maruti 800, it will
them is very high. If Maruti Udyog decides
Esteem. So it will formulate a proper priq
affect the demand for Mat-utiVans and Maruti
products. Further, Gillete Company produces
strategy fixingappropriate price for its various
complements with high cross elasticity of demand.If
both razors and razors blades which are
willgreatly increase the demand for razor bladdeg
it decides to lower the price of razors, it
strategy when it produces products withhigh
Thus there is need for adopting a proper price
positive or negative cross price-elasticity of demand.
frequently used in definingthe
Second, the concept of cross elasticity of demand is
between industries. An industry,
boundaries of an industry and in measuring interrelationship
is, products with a high positive
definedas a group of firms producing similar products (that
demand between MarutiEsteem.
cross elasticity of demand. For example, cross elasticity of
belong to the sarne
Hvundai Assent, Opel Astra is postiive and quite high. They therefore
interrelationship of firms
industw (i.e., automobiles). It should be noted that because of
and high, any one cannot
industries between which cross price-elasticity of demand is positive
industries.
raise price of its product without losing sales to other firms in the related
Further, the concept of cross elasticity of demand is extremly used in the United Statesin
deciding cases relating to Anti-trust laws and monopolistic practices used by firms. It so happens
that in order to reduce competition that one dominant firm producing a product with a high
cross elasticity of demand with the products of other firms tries to take over them and thereby
establish a monopoly or different firms try to merge with each other to form a cartel to enjoy
monopolistic profits. These actions are held illegal by Anti-trust or anti-monopoly laws.An
interesting attempt was made in India by Coca-Cola in 1995 when it returned to India following
the adoption of policy of liberalisation.In order to reduce competition, Coca-Cola company
purchasedthe firm producingThums Up, Gold Spot Limca which have high positivecros
elasticity of demand with Coca-Cola. It further made efforts to take over 'Pure Drinks', the
producer of Campa-Cola, another close substitutes but failed. If it had succeeded in its ventur e
it could have significantly reduced competition. With this its competition would have been
with other multinational rival firm Pepsi-Cola.

INCOME ELASTICITY OF DEMAND

Another important concept of elasticity of demand is income elasticity of demand. Income
elasticity of demand shows the degree of responsiveness of quantity demanded Of a good toa
small change in income of consumers. The degree of responsiveness of quantity demandedto
a change in income is measured by dividing the proportionate change in quantity demanded
by the proportionate change in income. Thus, more precisely, the income elasticity Of dem -
rnay be defined as the ratio of the proportionate change in the quantity purchased of a goodto
the proportionatechange in income which induces the former.
 Elasticity of Demand 303
Income Elasticity Proportionate change in purchases of a good
Proportionate change
in income
Thus, if the proportionate change in
purchases or quantity
thatof proportionatechange in income, income demanded of a good exceeds
elasticity will be greater than one. For example,
ifa 2 percent change in income leads to 5 per cent
change in quantity demanded of a good,
incomeelasticityof the demand for the good will be
LetM stand for an initial income, AM
for
quantitypurchaseddemand, AQ for a change a small change in income, Q for the initial
in quantity purchased
incomeandq for income elasticity of demand. Then as a result of a change in

AM-Q AM

Midpointformula for measuring income elasticity

of demand when changes in income
arequitelarge can be written as

Q2+Q1 • + Ml
2 2

Q2 + QI AM
AQ M2+M1
AM Q2+Q1
IncomeElasdcity, Normal Goods and Inferior Goods
It is important to note that the value of zero income elasticity of demand is of great
significance.Zero income elasticity of demand for a good implies that a given increase in
incomedoes not at all lead to any increase in quantitydemandedof the good or increase in
expenditure on it. In other words, zero income elasticity signifies that quantity demanded of
goodis quite unresponsive to changes in income. Besides, zero income elasticityis significant
becauseit represents a dividing line between positive income elasticityon the one side and
negativeincome elasticity on the other. When income elasticityis more than zero (that is,
Positive),then an increase in income leads to the increase in quantity demanded of the goods.
Thishappensin case of normal goods. On the other side there are all those goods which have
incomeelasticity less than zero (that is, negative) and in such cases increase in income leads to
thefallin quantitydemandedof the goods. Goods having negative income elasticity are
own as inferior goods. We thus see that zero income elasticity is a significant value, for it
representsa dividing line between positive income elasticity and negative income elasticity and
therefore helps us in distinguishing normal goods from inferior goods.
304 AdvancedEcorvn•c Theory
I•coæ Elu€citv, Luxuries and Necessities
Another v-ufxmt of ncorre elasticity is tnity. This is because when income
cf derræd for a god is equal to one, then proportion of income spent on the good r
the sæ-ræas consumer's income increases. Income elasticity of unity also represents a
Y the '-come elasticity for a is greater than one, the proportion of co usefu
Y-corre spent the as cons-mer's income increases, that is, that good bulks
n consuner•s as he becomes richer. On the other hand, If income elasticity for
good is kss one, the proportion of consumer's incorne spent on it falls as his income .
s. good relatively less important in consumer's expenditure as his
A hatirw income ela.sticitymore than and which therefore bulks larger
budget as he becomes richer is called a luxury. A good with an incom in
thæt and whichclaims dælining pror»rtion ofconsumer's income e
he richer is called a necessity. It shouki, howeær, be noted friat the definitiorsof
Enmes ard necessities on the basis of income elasticity may not conform to their definitions
n Engiish &tionary because the dictionanjs luxuries may be necessities and its necessities
rrw.y'be bones according to the above definition. But in economic theory it is useful to call the
elasticity greater than one as luxuries and goods with income elasticityless
than necessities.
Inco—eEl•sdcity Defined in Terms of Expenditure
We also express the income elasticity in terms of changes in expenditure madeon
the gcod rather than the change in quantity purchased of the good as a result of a changein
income. It shouE noted that expenditure is equal to the quantity purchased of the good
multipbed by the price of the good. If Q is the quantity purchased of the good and P the price
of the good, the expenditure made on the good will be equal to QP
As defined above,

Multiplying the numerator and denominator by P, we get

AQ.P M
Q.P AM
Now, as explained above, Q.P is the expendituremade on the good and AQ . P is the
change in expenditure made as a result of change in income. Let E stand for the expenditure
rnade on the god Then the above equation will become:

AE M

AE M

Change in expenditure on a good Income

Thus, income elasticity — x
Change in income Expenditure on a good
It is important to note that the value of zero income elasticity of demand is
Of great
significance. Zero income elasticity of demand for a good implies that a given increasein
 Elasticity of Demand 305
doesnot at all lead to any increase in
il€ome quantity demanded of the good or increase in
expenditureon it. In other words, zero income elasticity
is quite unresponsive to changes in income.
signifies that quantity demanded of
the Besides, zero income elasticityis significant
it represents a dividing line between positive income
incomeelasticityon the other. On the one side, elasticity on the one side and
when incomeelasticityis more than
(thatis, positive), then an increase in income leads to the
increase in quantity demanded
This happens in case of normal goods. On the
other side of zero income elasticity
thosegoods which have income elasticity less than zero
(that is, negative) and in such
increasein income will lead to the fall in quantity demanded
of the goods. Goods having
income elasticity are Known as inferior goods.
Wethusseethatzeroincome
is a significant value, for it represents a dividing line between
positive income elasticity
negativeincome elasticity and therefore help us in distinguishingnormal goods from
nierior goods.
Anotherünportant value of income elasticityis the reciprocal of proportion of consumer's
income spent on a good, that is V'Kx where K x stands for the proportionof consumer's
nome spenton a good X. The value of L/Kx for the income elasticityof demand seems to be
becausewhen income elasticity for a good equals 1/Kx, then the whole of the
significant
r,creasein consumer's income will be spent on the increase in quantitypurchasedof the good
x
proof: It is easy to show that when whole of the increase in income is spent on any good
! X, thenincomeelasticity is equal to the reciprocal of the proportion of income spent on the
gNd, that is, L.'Kx.
M AE
Weknowthat q =
AM
Suppose the whole of the increase in income (A M) is spent on the good X, then change
n (A E) on the good X would be equal to AM, price of good X remaining the same.
S±stituångA M for A E in the above measure of income elasticity,we get

1 (where EM = proportion
of income spent on good X).

It be further noted that if income elasticity of demand for a good is greater than
1K then more than the increase in consumer's income would be spent on the good and vice

MeueringIncome Elasticity at a Point on an Engel Curve

of a good and level of
An Engel curve shows the relationship between quantity demanded
more quantity of the good is
incorne. Since with the increase in income normally
slope). As seen in a previous
Engelcurve slopes upward (i.e. it has a positive it is of different shape for
chaÄer,thqh Engel curve for normal goods slopes upward but
the good is a necessityor a
åffermtgcds. It is convex or concave, depending on whether
is negative, that is, less is demanded
In case of an inferior good for which income effect
We will first explain how income elasticity
rises. Engel curve is backward bending.