Business Economics · Theory of Demand and Supply

Elasticity of Demand for CA Foundation Business Economics

Updated 1 October 2026 · Fact-checked

Elasticity of demand measures how much quantity demanded changes when price, income or another good's price changes. Price elasticity = % change in quantity demanded ÷ % change in price. Income and cross elasticity use the same ratio with income or the other good's price. Find the percentage changes, divide, then read the size and sign.

Understand Elasticity of Demand

Demand tells you that people buy less when price rises. It does not tell you how much less. Elasticity of demand gives that number. It is the responsiveness of quantity demanded to a change in one of its determinants.

There are three kinds you must know:

Price elasticity of demand: response of quantity demanded to a change in the good's own price.
Income elasticity of demand: response of quantity demanded to a change in consumer income.
Cross elasticity of demand: response of quantity demanded of good X to a change in the price of a different good Y.

Price elasticity is usually quoted as a positive number (its absolute value), because the demand curve slopes downward. Then the size tells the type. If it is greater than 1, demand is elastic: quantity changes by a bigger percentage than price. If it is less than 1, demand is inelastic. If it is exactly 1, demand is unitary elastic. The two extremes are perfectly elastic (infinite, a horizontal curve) and perfectly inelastic (zero, a vertical curve).

For income and cross elasticity the sign matters. Positive income elasticity means a normal good, and above 1 it is a luxury. Negative income elasticity means an inferior good. Positive cross elasticity means substitutes (tea and coffee). Negative cross elasticity means complements (car and petrol). Zero means the goods are unrelated.

Elasticity is higher when a good has close substitutes, is a luxury, takes a large share of income, is not a habit or need, and when buyers have more time to adjust. Necessities, goods with no substitutes, and cheap items tend to be inelastic. The same good can have different elasticities for different price ranges, so always read the question's data carefully.

Key formulas to remember

Price elasticity (percentage method): Ed = (% change in quantity demanded) ÷ (% change in price) = (ΔQ ÷ Q) ÷ (ΔP ÷ P); Use original Q and P as the base. Take the absolute value when classifying. Ed > 1 elastic, Ed < 1 inelastic, Ed = 1 unitary.
Point elasticity: Ed = (dQ ÷ dP) × (P ÷ Q); Used for a very small change at one point. For a linear demand Q = a − bP, Ed = b × P ÷ Q (absolute value). On a straight-line demand curve, Ed = lower segment ÷ upper segment at that point.
Arc elasticity (midpoint form): Ed = (ΔQ ÷ ΔP) × ((P1 + P2) ÷ (Q1 + Q2)); Used for a larger change between two points. It uses averages as the base, so the answer is the same whether price rises or falls.
Total outlay (expenditure) method: Price falls and total expenditure rises → Ed > 1; unchanged → Ed = 1; falls → Ed < 1; If price rises, the directions reverse: expenditure falls means Ed > 1. Total expenditure = P × Q.
Income elasticity of demand: EY = (% change in quantity demanded) ÷ (% change in income); EY > 0 normal good; EY > 1 luxury; 0 < EY < 1 necessity; EY < 0 inferior good.
Cross elasticity of demand: Exy = (% change in quantity of X) ÷ (% change in price of Y); Positive means substitutes, negative means complements, zero means unrelated goods.
Types of price elasticity: Ed = 0 perfectly inelastic; 0 < Ed < 1 inelastic; Ed = 1 unitary; 1 < Ed < ∞ elastic; Ed = ∞ perfectly elastic; Perfectly elastic is a horizontal demand curve; perfectly inelastic is a vertical one.

How to solve Elasticity of Demand questions

Use this order for any numerical or conceptual question on elasticity. It keeps you from mixing up bases and signs.

1Identify which elasticity is asked: price (own price), income, or cross (another good's price).
2Write down the old and new values of price (or income) and quantity. Compute ΔQ and ΔP (or ΔY) with signs.
3Choose the method. If the question says 'arc', 'between two points' or 'average', use the midpoint formula. If it gives a demand function and one price, use the point formula. Otherwise use the percentage method on original values.
4Substitute and calculate. Keep percentages as fractions where possible to avoid rounding.
5Ignore the minus sign for price elasticity when classifying. Keep the sign for income and cross elasticity.
6Interpret the result: compare with 1 for price elasticity; check sign for income and cross elasticity.
7Match your value to the four options. Check that the option has the right size and the right interpretation.

Quickest way: Fast route for elasticity MCQs

When to use it: Use under time pressure in the 2-hour objective paper, where each wrong answer costs 0.25 marks.

Convert changes to simple fractions or percentages in your head: ₹20 to ₹16 is −20%, 100 to 130 is +30%.
Divide the two percentages directly. Do not compute extra values you do not need.
If the question asks only 'elastic or inelastic', use total outlay: compare P × Q before and after. No division needed.
For arc elasticity, compute (ΔQ ÷ ΔP) first, then multiply by the sum of prices over the sum of quantities. A quick check: the answer should lie between the two percentage-method answers (from old base and from new base).
Eliminate options with the wrong sign (for cross and income) or the wrong class (for example, an answer of 0.5 when outlay rose after a price fall).
If a question needs long calculation and you are unsure, mark it for later. Do not guess blindly unless you can remove two options.

Common mistakes in Elasticity of Demand

Using the new value as the base for percentage change in the percentage method.
Students divide the change by the final figure because it is the latest number on the page.
Fix: Divide by the original (old) price and quantity unless the question asks for arc or midpoint elasticity.
Mixing up arc and percentage method answers.
Both use the same data, so students apply whichever formula they remember first.
Fix: Read the wording. 'Arc elasticity' or 'average' means use (P1 + P2) and (Q1 + Q2). Otherwise use the original base.
Calling the good elastic because the minus sign looks large or small.
Students forget that price elasticity is read by its absolute value.
Fix: Drop the minus sign for price elasticity, then compare the size with 1.
Dropping the sign in income and cross elasticity.
Students carry the habit of ignoring the negative sign from price elasticity.
Fix: Keep the sign. Negative income elasticity means an inferior good. Negative cross elasticity means complements.
Treating slope of the demand curve as elasticity.
A flatter curve looks more elastic, so students think slope and elasticity are the same.
Fix: Elasticity uses percentage changes and depends on the point on the curve. Along a straight-line demand curve, slope is constant but elasticity changes at every point.
Reading total outlay wrongly when price rises.
Students memorise the price-fall rule and apply it unchanged to a price rise.
Fix: For a price rise, expenditure falling means elastic demand, and expenditure rising means inelastic demand. Always check the direction of price first.

Worked examples

Example 1

When the price of a good falls from ₹20 to ₹16, quantity demanded rises from 100 units to 130 units. Using the percentage method, the price elasticity of demand is: (a) 0.67 (b) 1.00 (c) 1.50 (d) 2.50

Show the solution

ΔP = 16 − 20 = −4. % change in price = −4 ÷ 20 × 100 = −20%.
ΔQ = 130 − 100 = 30. % change in quantity = 30 ÷ 100 × 100 = +30%.
Ed = 30 ÷ (−20) = −1.5. Absolute value = 1.5.
Since 1.5 > 1, demand is elastic. Check with total outlay: old = 20 × 100 = ₹2,000; new = 16 × 130 = ₹2,080. Price fell and outlay rose, which confirms Ed > 1.

Answer: (c) 1.50

Example 2

The price of a good falls from ₹10 to ₹8 and quantity demanded rises from 40 units to 60 units. The arc elasticity of demand (absolute value) is: (a) 0.8 (b) 1.2 (c) 1.8 (d) 2.5

Show the solution

ΔQ = 60 − 40 = 20. ΔP = 8 − 10 = −2.
ΔQ ÷ ΔP = 20 ÷ (−2) = −10.
P1 + P2 = 10 + 8 = 18. Q1 + Q2 = 40 + 60 = 100. Ratio = 18 ÷ 100 = 0.18.
Arc elasticity = −10 × 0.18 = −1.8. Absolute value = 1.8.
Note that 2.5 is the percentage-method answer from the original base (+50% ÷ −20%). It is the trap option here, because the question asks for arc elasticity.

Answer: (c) 1.8

Example 3

The price of tea rises from ₹40 to ₹50 per packet. As a result, the quantity demanded of coffee rises from 200 units to 230 units. The cross elasticity of demand of coffee with respect to the price of tea, and the relationship between the goods, is: (a) +0.6, substitutes (b) −0.6, complements (c) +1.67, substitutes (d) −1.67, complements

Show the solution

% change in price of tea = (50 − 40) ÷ 40 × 100 = +25%.
% change in quantity of coffee = (230 − 200) ÷ 200 × 100 = +15%.
Exy = 15 ÷ 25 = +0.6. The numerator is the good whose quantity changes (coffee), and the denominator is the price change of the other good (tea).
The sign is positive: when the price of tea rises, demand for coffee rises. So the goods are substitutes.
Option (c) is wrong because it inverts the ratio (25 ÷ 15).

Answer: (a) +0.6, substitutes

Exam tips

Look for the keyword that selects the method: 'arc', 'between the two prices' or 'average' means the midpoint formula; a demand function with a given price means point elasticity.
Check what the question wants: a number, a class (elastic or inelastic) or a relationship (substitute or complement). The same data can give all three, and options often mix them.
Expect conceptual MCQs too: match goods to elasticity (salt is inelastic, luxury goods are elastic), identify the curve shape for Ed = 0 and Ed = ∞, and link elasticity to total expenditure.
Practise reading options for traps: the original-base percentage answer, the inverted ratio and the wrong sign are the usual distractors.
Because wrong answers cost 0.25 marks, attempt a numerical only if you can finish it quickly or can eliminate two options by sign or class.

Practice questions from Theory of Demand and Supply

Elasticity of Demand: frequently asked questions

What is the formula for price elasticity of demand?

Price elasticity of demand = % change in quantity demanded ÷ % change in price. It equals (ΔQ ÷ Q) ÷ (ΔP ÷ P). Use the absolute value to decide whether demand is elastic (above 1), inelastic (below 1) or unitary (equal to 1).

What is the difference between arc elasticity and point elasticity?

Point elasticity measures responsiveness at a single point on the demand curve, for a very small change in price. Arc elasticity measures it over a stretch between two points, using the average of the prices and quantities as the base. Use arc when the question gives two prices and two quantities.

How do price, income and cross elasticity differ?

Price elasticity links quantity demanded to the good's own price. Income elasticity links it to consumer income. Cross elasticity links it to the price of another good. Price elasticity is read by size, while income and cross elasticity are read by sign as well.

How do I know if two goods are substitutes or complements from cross elasticity?

Look at the sign. A positive cross elasticity means that when the price of one good rises, demand for the other rises, so they are substitutes. A negative sign means demand for the other falls, so they are complements.

Does a negative sign in price elasticity mean anything?

It only shows that price and quantity demanded move in opposite directions, which is the normal law of demand. For classifying demand as elastic or inelastic, ignore the sign and look at the size.