Elasticity of Demand
Elasticity of Demand
OF
DEMAND
ELASTICITY OF DEMAND
Perfectly elastic
When the
P demand curve demand for a
R product changes
I
D
–increases or
C D
decreases even
E
when there is no
change in price,
it is known as
perfect elastic
0 x
demand.
ED=infinity
Perfectly inelastic demand
Y
D
When a change in
price, howsoever
Perfectly inelastic
P demand curve large, brings no
R changes in quantity
demand, it is known
I
as perfectly inelastic
C
demand
E
0 D X
demand
Elasticity of demand equal to utility
When the
y
D
proportionate
P
change in
R
demand is equal
I Elasticity of
C
demand equal to proportionate
E
to utility curve changes in price,
D
it is known as
unitary elastic
0 demand
x demand
Relatively elastic or elastic demand
When the
y proportionate
P Relatively elastic change in
R demand curve quantity
D
I demanded is
C more than the
E
proportionate
D
change in price,
it is known as
relatively elastic
0 x
demand
demand.
Relatively inelastic or inelastic demand
Y
D When the
Relatively inelastic
demand curve
proportionate
change in demand
P
is less than the
R proportionate
I changes in price, it
C is known as
E relatively inelastic
demand
D
O X
demand
ALL KINDS OF DEMAND CAN BE SHOWN
IN ONE DIAGRAM AS FOLLOW
Y
WHERE
P D1) Perfectly elastic
R demand
D
I D1 D2)Relatively elastic
C demand
D2 D3)Elasticity of demand
E
D3
equal to utility
D4
D4)Relatively inelastic
0 D5 X demand
DEMAND D5)Perfectly inelastic
demand
• The concept of elasticity of demand plays a
crucial role in business-decisions:
– Price-elasticity of demand for the product.
– Price- elasticity of demand for its substitutes.
Measurement Of Price Elasticity Of
Demand
There are main methods like
1. Total expenditure method
2. Percentage method or proportionate
method
3. Arc method
4. Geometric method or point method
Total Expenditure Method
• Given by Dr. Marshall.
• According to this method, in order to measure
the elasticity of Demand, it is essential to
know how much and in what direction the
total expenditure has changed as a result of a
change in price of a good.
• TE = P*Q
• It considers three types of elasticity
• ED=1, when due to rise or fall in price of a
good, T.E. remains unchanged.
• ED>1, when due to fall in price, T.E. goes up
and due to rise in price T.E. goes down.
• ED<1, when due to fall in price, T.E. goes down
and due to rise in price, T.E. goes up.
Percentage method or proportionate method
Questions
• Price of ice cream is Rs. 4 and demand is for 1
unit of ice cream. When price of ice cream
falls to Rs. 2, demand extends to 4 units of ice
cream. Calculate ED.
• Find elasticity of demand as price falls from
Rs.3 to Rs. 2 and when price increases from
Rs.2 to Rs.3.
Price 5 4 3 2 1
Quantity 10 20 25 35 40
• Original Price = Rs. 4
• Original Quantity = 1
• New Price = Rs. 2
• New Quantity = 4
• Change in Price = - 2
• Change in Quantity = 3
• Price Elasticity of Demand = 3/2 x 4/1 = 6
Arc elasticity
• The arc elasticity of x is defined as:
• (change in Q / average Q )
---------------------------
(change in P / average P)
• Or (change in Q / Q1 + Q0/2)
---------------------------
(change in P / P1+ P0/2)
Point Elasticity of Demand
• Measures elasticity at any point on the
demand curve.
• ED= lower portion of demand curve
Upper portion of demand curve
(5) Factors Affecting Price Elasticity Of
Demand
Factors Affecting Price Elasticity Of Demand
• Nature of the Commodity
• Availability of Substitutes
– Goods having substitutes have elastic demand.
– Commodities that do not have any substitutes have
inelastic demand.
• Variety of uses of commodity
– Goods that can be put to different uses have elastic
demand.
Factors Affecting Price Elasticity Of
Demand
• Postponement
– Goods whose demand can be postponed to a future period
have elastic demand.
• Influence of habits
– DD for those goods is inelastic to which the consumer
become habituated.
• Proportion of Income spent on a commodity
– Goods on which a consumer spent a very small proportion
of his income have inelastic demand.
– Goods on which a consumer spends a large proportion of
his income have elastic demand.
Factors Affecting Price Elasticity Of
Demand
• Range of prices
– Very high priced goods have inelastic demand. Change
in price of these goods causes little change in their
demand.
• Income Groups
– People with high or very low income, have inelastic
demand. Demand of middle income people is elastic.
• Elements of time
– Demand for goods is inelastic in short period and elastic
in long run.
(6) Practical Importance of the
Concept of Price Elasticity Of
Demand
Practical Importance of the Concept of Price
Elasticity Of Demand
• The concept is helpful in taking Business
Decisions and to determine the price of their
product.
• Importance of the concept in formatting
Indirect Tax Policy of the government
• For determining the rewards of the Factors of
Production
• To determine the Terms of Trade Between the
Two Countries
Income Elasticity Of Demand
Advertising Elasticity of ∆S ∆A
/
Demand = S A
• IF Ea = 0, sales do not respond to adv. Exp.
• If Ea>0 but <1, % change in sales < % change in
adv. Exp.
• Ea = 1, % change in sales = % change in adv.
Exp.
• Ea>1, sales increase at higher rate than rate of
increase in adv. Exp.
Price Expectation Elasticity