Demand Elasticity
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Price elasticity of demand is a measurement of the change in the consumption of a product in relation to a change in its price. Expressed mathematically, it is:Economists use price elasticity to understand how supply and demand for a product change when its price changes. Like demand, supply also has an elasticity, known as price elasticity of supply. Price elasticity of supply refers to the relationship between change in supply and change in price. It’s calculated by dividing the percentage change in quantity supplied by the percentage change in price. Together, the two elasticities combine to determine what goods are produced at what prices.
Definition
Demand elasticity measures the relationship between changes in the quantity demanded of a product and changes in its price. It is expressed mathematically as the ratio of the percentage change in quantity demanded to the percentage change in price. Demand elasticity helps economists understand how supply and demand for a product change with price variations.
Origin
The concept of demand elasticity originated in the 19th century and was systematized by economist Alfred Marshall in his book 'Principles of Economics'. Marshall's work laid the foundation for modern microeconomics, making demand elasticity a crucial tool for analyzing market behavior.
Categories and Features
Demand elasticity can be categorized into several types: perfectly elastic, perfectly inelastic, unitary elastic, elastic, and inelastic. Perfectly elastic means a small price change leads to an infinite change in quantity demanded; perfectly inelastic means price changes do not affect quantity demanded. Unitary elasticity implies that the percentage change in price and quantity demanded are equal. Elastic demand indicates that the quantity demanded changes more than the price change, while inelastic demand is the opposite. The application scenarios of demand elasticity vary under different market conditions, such as luxury goods typically having higher demand elasticity, whereas necessities have lower elasticity.
Case Studies
A typical case is Apple Inc.'s iPhone. The demand for iPhones is relatively inelastic because consumers are willing to buy them even if prices increase, indicating low demand elasticity. Another example is the gasoline market. Since gasoline is a necessity, its demand elasticity is also low, and price increases usually do not significantly reduce demand.
Common Issues
Common issues investors face when applying demand elasticity include misunderstanding the relationship between elasticity and total revenue. Generally, a price increase leads to higher total revenue, but in the case of elastic demand, a price increase might lead to a decrease in total revenue. Additionally, demand elasticity is not constant; it can change due to market conditions, consumer preferences, and the availability of substitutes.
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