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Elasticity Coefficient Definition
Elasticity coefficient is an economic measure that is used for determining percentage fluctuation in one variable with respect to 1% variation in another variable. It is the rate of variation in demanded quantity in response to a 1% change in the product’s price.
The term elasticity refers to the extent to which dependent variable changes when an external force is applied to it (change in the independent variable). Thus, the coefficient of price elasticity of demand signifies to what extent a product’s demand is sensitive to price changes.
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- The elasticity coefficient is a numerical measure of the degree of variation in one variable (dependent) in response to 1% changes in another variable (independent variable).
- The coefficient indicates the percentage shift in the quantity demanded caused by a 1% change in price.
- The elasticity coefficient is expressed as follows:
‘E = (%∆y) / (%∆x), or E = (%∆Q) / (%∆P).’ - When, E = 0, perfect inelasticity is witnessed, E < 1 shows inelasticity, E = 1 signifies unitary elasticity, E > 1 resembles elasticity, and E = ∞ indicates perfect elasticity.
Elasticity Coefficient Explained
The elasticity coefficient is a measure of the extent to which the value of one variable fluctuates due to changes in another variable. For example, if y is a dependent variable and x is an independent variable, then the value of y responds to the rise or fall in the value of x.
In economics, there are four different types of elasticity—the elasticity of demand, price elasticity of supply, income elasticity, and cross elasticity. But, for understanding the coefficient, the focus is on 'demand elasticity.'
A commodity is considered 'price-elastic' when commodity demand increases with the fall in prices or decreases with the increase in the price. In contrast, if changes in prices cause negligible or no change in commodity demand, the commodity is considered price inelastic.
Elasticity Coefficient Formula
The coefficient gauges the degree of change in the demand for a certain commodity when the price varies by 1%.
The formula used for the evaluation of the elasticity coefficient is as follows:
Here,
- E is the elasticity coefficient.
- %∆y is the percentage change in the value of the dependent variable.
- %∆x is the percentage change in the value of the independent variable.
- %∆Q is the percentage change in the quantity of a product demanded.
- %∆P is the percentage change in the product's price.
Interpretation
The law of demand states that changes in product prices cause changes in product demand. Let us discuss five different interpretations of the coefficient:
Case 1: If E = 0
The elasticity coefficient is 0 when the change in prices does not affect product demand. In such a scenario, product demand is perfectly inelastic (to price). However, this is common; demand for necessary goods and services remains constant despite price fluctuations.
Case 2: If E < 1
When the percentage rise or fall in the demand of a commodity is comparatively less than the change in commodity price, then commodity demand is inelastic to price.
Case 3: E = 1
When the coefficient is 1, the demand for the commodity changes at the same rate at which the price fluctuates. In such a scenario, commodity demand is unitary elastic (to price).
Case 4: E > 1
If the product demand rises or falls significantly—in response to even a slight change in its price, then product demand is elastic to price. For instance, luxury goods are highly price-sensitive—even minor price changes cause a massive rise or fall in demand.
Case 5: E = ∞
When the change in product demand is infinite in response to a minute change in prices, the product is considered perfectly elastic (to price). It is an extreme scenario and, therefore, theoretical.
Examples
Let us understand the elasticity coefficient with the help of the following examples:
Example #1
The price of rice rises from $0.67 per kg to $0.71 per kg, but the demand for rice (quantity demanded) remains the same, at 10000 quintals. Now, based on given values, evaluate the coefficient of price elasticity of demand.
Solution:
Given:
%∆Q = 0%
%∆P = × 100 = 5.97%
E = (%∆Q) / (%∆P)
E = 0 / 5.97 = 0
Thus, in the given scenario, the demand for rice is perfectly inelastic to its price.
Example #2
ABC showroom experienced a fall in demand for luxury cars. Product demand fell from 540 units to 386 units within a year. During the same period, the price of cars was raised from $92000 to $96000. Based on given values, determine the coefficient of price elasticity of demand.
Solution:
Given:
%∆Q = × 100 = 28.52%
%∆P = × 100 = 4.35%
E = (%∆Q) / (%∆P)
E = 28.52 / 4.35 = 6.56
Since E > 1, the demand for the luxury car is considered highly elastic to price.
Frequently Asked Questions (FAQs)
It is the degree of variation in the quantity of a commodity demanded with respect to (percentage) change in prices.
If E is the coefficient; %∆Q is the percentage change in quantity demanded, and %∆P is the percentage change in the product price, then the elasticity coefficient is expressed as follows:
E = %∆Q / %∆P
Following are the various interpretations:
E = 0, then product demand is perfectly inelastic to price.
E < 1, then product demand is inelastic to price.
E = 1, then product demand is unitary elastic (to price).
E > 1, then product demand is elastic to price.
E = ∞, then the product demand is perfectly elastic to its price.
If the coefficient is zero, then fluctuation in product prices causes no change in product demand. In such a scenario, product demand is perfectly price-inelastic.
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