Understanding Market Elasticity: Demand, Supply, and Income Effects

Posted on Dec 8, 2025 in Economics

Elasticity: Definition and Concepts

Elasticity measures the percentage change in quantity demanded or supplied in response to percentage variations in other dependent variables (such as price or income). When analyzing supply and demand curves, elasticity is present at each and every point. A curve is said to have constant elasticity if the value remains the same across all points.

Price Elasticity of Demand (PED)

The Price Elasticity of Demand (PED) measures the percentage variation in quantity demanded resulting from percentage variations in the price of the good itself. The sign of the demand elasticity is always negative because price and quantity demanded move in opposite directions (due to the Law of Demand). However, its value is typically taken in absolute terms for classification purposes.

Arc Elasticity Calculation

Elasticity is different at every point along the demand curve. The value will differ whether moving up or down the curve. If we want the elasticity value to be the same regardless of the direction of movement (upwards or downwards), economists use arc elasticity.

Types of Price Elasticity of Demand

The classification of demand elasticity depends on the absolute value of the coefficient (E):

  • Unitary Elastic Demand (E = 1): Quantity demanded and price vary by the same proportion.
  • Elastic Demand (E > 1): The percentage change in quantity demanded is greater than the percentage change in price.
  • Inelastic Demand (0 < E < 1): The percentage change in quantity demanded is smaller than the percentage change in price.
  • Perfectly Inelastic Demand (E = 0): Price variations cause no change in quantity demanded. The demand curve is vertical (rigid).
  • Perfectly Elastic Demand (E = ∞): A tiny price variation leads to an unlimited increase or decrease in quantity demanded. The demand curve is horizontal (decisive).

Key Determinants of Demand Elasticity

Several factors influence how elastic or inelastic the demand for a good is:

  1. Percentage of Income Spent on the Good: Goods that consume a small percentage of a consumer’s income tend to have a more inelastic demand compared to goods where a larger percentage of income is spent, which tend to have a more elastic demand.
  2. Availability of Substitutes: Goods with many close substitutes tend to have more elastic demand than those with few or no substitutes.
  3. Classification as Necessity or Luxury: Goods considered necessities generally have a more inelastic demand, while luxury goods tend to have a more elastic demand.
  4. Time Horizon: Demand tends to become more elastic over the long term, as consumers have more time to adjust their consumption patterns and find suitable substitutes.

Income Elasticity of Demand (YED)

Income Elasticity of Demand (YED) measures the percentage change in quantity demanded resulting from percentage variations in consumer income. YED is crucial for classifying different types of goods.

Values and Classification by Income Elasticity

  • Negative YED (EY < 0): Inferior Goods. An increase in income decreases the quantity demanded of the good.
  • Positive YED (EY > 0): Normal Goods. An increase in income increases the quantity demanded. Normal goods are further divided:
    • Necessity Goods (0 < EY < 1): Demand increases less than proportionally to the increase in income.
    • Luxury Goods (EY > 1): Demand increases more than proportionally to the increase in income.

Cross-Price Elasticity of Demand (XED)

The Cross-Price Elasticity of Demand (XED) measures the percentage change in the quantity demanded of one good (Good A) in response to a percentage variation in the price of another good (Good B). XED is used to establish the relationship between two goods.

Values and Relationships by Cross-Price Elasticity

  • Negative XED (EX < 0): Complementary Goods. An increase in the price of Good B leads to a decrease in the quantity demanded of Good A. These goods are consumed together.
  • Zero XED (EX = 0): Independent Goods. A change in the price of Good B causes no change in the quantity demanded of Good A.
  • Positive XED (EX > 0): Substitute Goods. An increase in the price of Good B leads to an increase in the quantity demanded of Good A.

Price Elasticity of Supply (PES)

Price Elasticity of Supply (PES) measures the percentage change in quantity supplied resulting from a percentage variation in price. The sign of supply elasticity is always positive because price and quantity supplied move in the same direction (due to the Law of Supply).

Values of Supply Elasticity

  • Perfectly Inelastic Supply (ES = 0): The supply curve is vertical (rigid). Price variations cause no change in quantity supplied.
  • Perfectly Elastic Supply (ES = ∞): The supply curve is horizontal. Producers are willing to supply any quantity at a specific price.
  • Unitary Elastic Supply (ES = 1): Price variations and quantity supplied vary by the same proportion.
  • Inelastic Supply (0 < ES < 1): The percentage increase in quantity supplied is less than the percentage increase in price.