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Elasticity of Demand

Price elasticity of Demand = % change in Quantity demanded / %change in Price

%change = change in value / Average Value
  • If absolute value > 1, demand is elastic;
  • If absolute value < 1, demand is inelastic
  • If absolute value = 1, demand is unit elastic.
Types of Demands

Elastic demand:
A small price increase causes a large decrease in quantity demanded.

Inelastic demand: A large price increase causes a small decrease in quantity demanded.

Perfectly elastic demand: A small price increase reduces the quantity demanded to 0.

Perfectly inelastic demand: A price change does not affect the quantity demanded.

Income Elastcity

Income elasticity of Demand = % change in Quantity demanded / % change in income.

Cross Elasticity 

Cross elasticity of Demand = % change quantity demanded / % change in price of substitute or complement.

Price elasticity

It has two main determinants:
  • Availability of substitutes: If substitute goods are available, consumer may switch to a substitute good if price rise. The presence of many substitutes may tend to increase demand elasticity.
  • Share of budget spent on product: goods that occupy relatively small portion of your budget will tend to be price inelastic.
  • An inferior good has -ve income elastic.
  • An normal good has +ve income elastic.
Sample Questions

Q: The cross elasticity of demand for a substitute good and the income elasticity for an inferior good are:
Cross elasticity Income elasticity
A. < 0  > 0, < 1
B. < 0  < 0
C. > 0  > 0, < 1
D. > 0  <0

Answer: A

Q: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy decreases from 10 to 8 cones, then your elasticity of demand would be calculated as:


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