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Economic Theory

demand in a market is great or small according as the amount demanded
increases much or little for a given fall in price and diminishes much or
little for a given rise in price.” We may thus define elasticity of demand as
the ratio of the percentage change in quantity demanded to the percentage

change in price.
The most familiar example in microeconomics is the relationship

between the quantity of a good demanded by consumers and the good’s
own price. We know from the law of demand that when the price of a good
increases, the quantity demanded generally falls. But what we do not know
from this law is by how much quantity demanded falls. The price elasticity

of demand measures the percentage change in quantity demanded of a
good resulting from a percentage change in the good’s price. Formally, the
price elasticity of demand is calculated as:

(5.3)

Demand may be elastic or inelastic. When due to a small change in
price, there is a great change in demand, it is said that demand is elastic. If

a 5 percent cut in prices of car results in an increase in 30 percent in sales,
demand is said to be highly elastic. In other words, demand has responded
greatly. On the other hand, if a great change in price is followed by a small

change in demand, it is inelastic demand. For example, the demand for salt
is said to be inelastic because same quantity of it will be purchased even if
price rises or declines. Whereas, demand for a car is elastic because a

small rise/fall in price may greatly reduce/increase its demand.
Because of the importance of the price elasticity of demand,
economists have developed a terminology to classify goods based on the

magnitude of the price elasticity. There are five cases/kinds of price
elasticity of demand. These are as follows:
Elastic Demand (Ep1). Goods with a price elasticity of demand
greater than 1 have elastic demand. When the price elasticity of demand is

greater than 1, the percentage change in quantity demanded is greater than
the percentage change in price. Economic research has shown that peanut
butter and olive oil tend to have elastic demand.

Inelastic Demand (Ep1). Goods with a price elasticity of demand
less than 1 have inelastic demand. When the price elasticity of demand is
less than 1, the percentage change in quantity demanded is less than the

percentage change in price. Research within economics has taught us that

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