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Elasticity of Demand

The document discusses the concept of elasticity of demand, which measures how demand for a commodity responds to changes in price and other factors. It outlines different types of elasticity, including price elasticity, income elasticity, and cross elasticity, along with methods for measuring them. Additionally, it highlights factors affecting elasticity and the practical importance of understanding elasticity in business and economic decision-making.

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0% found this document useful (0 votes)
16 views43 pages

Elasticity of Demand

The document discusses the concept of elasticity of demand, which measures how demand for a commodity responds to changes in price and other factors. It outlines different types of elasticity, including price elasticity, income elasticity, and cross elasticity, along with methods for measuring them. Additionally, it highlights factors affecting elasticity and the practical importance of understanding elasticity in business and economic decision-making.

Uploaded by

ankitjaincool266
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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ELASTICITY

OF
DEMAND
ELASTICITY OF DEMAND

• The Elasticity of demand is the responsiveness


of demand of a commodity with respect to
change in its price & other factors affecting the
demand of that commodity.
• The change in the quantity demanded of a
commodity due to a change in its price,
consumer’s income, price of substitute goods
or complementary goods or expenditure made
on advertisement is called elasticity of demand.
Definition Of Price Elasticity Of Demand

• The change in the quantity demanded of a


product, due to a change in its price is known
as Price elasticity of demand.

• Thus, the % sensitiveness or responsiveness


of demand, due to the % change in price is
called price elasticity of demand
• Ped =
% change in quantity demanded / % change in price

• % change in quantity demanded =


Change in quantity demanded / Original Demand x 100
• % change in price =
Change in price / Original price x 100
Percentage method or proportionate method
Degrees Of Price Elasticity Of Demand
1) Perfectly elastic demand
2) Relatively elastic demand
3) Elasticity of demand equal to utility
4) Relatively inelastic demand
5) Perfectly inelastic demand
Perfectly elastic 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

Income Elasticity Of Demand-It


is a proportionate change in
the demand for a good
in response to a change
in income
Types Of Income Elasticity Of Demand

• Income Elasticity Equal to Unity or One


• Income Elasticity Greater Than Unity
• Income Elasticity Less Than Unity
• Negative Income elasticity of demand
Implications of Income elasticity of
demand
• Positive Income elasticity of demand
(normal/ essential goods)
• Negative Income elasticity of demand
(inferior goods)
• Zero /less than 1 Income elasticity of
demand (necessity goods)
• Greater than unity Income elasticity of
demand (comforts/ Luxury goods)
Measurement Of Income Elasticity Of
Demand

Proportionate change in Demand


Income Elasticity Of Demand =
Proportionate change in Income
i.e. ∆q ∆y
Income Elasticity Of Demand = /
Q Y
Measurement Of Income Elasticity Of
Demand
• Here , ∆q = Change in the quantity demanded.
Q = Original quantity demanded.
∆y = Change in income.
Y = Original income.
• For e.g. ,when Income of the consumer =
3000/- , he purchases 10 units of X, when
income = 6,000/- he purchases 30 units of X
Cross Elasticity of Demand

• Cross elasticity of demand expresses a


relationship between the change in the
demand for a given product in response to a
change in the price of some other product
• E.g. if the demand for tea reduces
tremendously than its effect could be seen in
demand of sugar and milk.
Types of Cross Elasticity of Demand

• Cross Elasticity of Demand Equal to Unity or


One
• Cross Elasticity of Demand Greater than Unity
or one
• Cross Elasticity of demand less than unity or
one
Measurement of Cross Elasticity of
Demand
Proportionate change in Demand
for product X
Cross Elasticity of Demand =
Proportionate change in Price of
i.e. product Y

Cross Elasticity of Demand = ∆qx ∆p y


/
Qx Py
Importance of Cross Elasticity Of
Demand
• The concept is of very great importance in changing the
price of the products having substitutes and
complementary goods . If Cross elasticity coefficient is (+)
goods are substitute; higher the positive co-efficient closer
the substitute. And if it is (-) goods are complementary ;
higher the negative co-efficient higher the degree of
complementarity.
• In demand forecasting
• Helps in measuring interdependence of price of commodity
• Multiproduct firms use these concept to measure the effect
of change in price of one product on the demand of their
other product
• The price of coffee increases from Rs. 50 per
kg to Rs. 70 per kg and as a result the demand
for tea increases from 5 kg to 10 kg. What is
the cross elasticity of demand of tea for
coffee?
Advertisement Elasticity of demand
• Advertising occupies an imp. place in a
competitive or a partially competitive economy.
– Some sales are possible even if there is no
advertising.
– Beyond the minimum level of sales, there is a direct
relationship between advertising exp. and sales.
– Consumer need a minimum level of advertisement
before they take notice of the presence of the
product.
Measurement of Advertising 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

• It measures expected change in future price as


a result of change in current prices of a
product.

• Ex = Change in future price/ Change in current


price x Current price/Future price

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