SUBJECT: MICRO ECONOMICS

B.com 1st Semester

UNIT-1

Give a brief introduction on economics?

Economics is regarded as a very important branch of knowledge in modern times. It

is looked upon as a “social science” as it studies the behaviour of human being in the
society. According to Samuelson, ‘Economics is the oldest of the arts and the
nearest of the science, indeed the “QUEEN OF SOCIAL SCIENCE”. Although it is a
social science, it does not study at activities of the people living in the society. It
studies only economic activities of the individuals living in the society. However, it is
very difficult to give a precise meaning of economics.

ORIGIN OF ECONOMICS

The term “Economics’ is believed to be derived from two Greek words –

 Oikus ( a household) and
 Nemien (to manage)

Thus, Economics may be defined as a ‘science which studies the management of

households with limited funds available.’

What is “Economics”?

However, different economists, viz. Adam Smith, Alfred Marshal, Lionel Robbins,
Paul Samuelson have defined economics in different manner.

According to prof. Adam smith, “Economics is a science of wealth.” That means

earning and spending of wealth is the subject matter of economics.

According to Alfred Marshall, “Economics is a study of mankind in ordinary business

of life, it examines that part of individual and social action which is most closely
connected with the attainment and use of material requisites of well-being.”

According to Lionel Robins, “Economics is the science which studies human

behaviour as a relationship between ends (means unlimited human wants) and
scarce means (limited resources) which have alternative uses.”

According to Paul Samuelson, “ Economics is the study of how men and society
choose, with or without the use of money, to employ scarce productive resources
which could have alternative uses, to produce various commodities over time and
distribute them for consumption now and in the future among various people and
groups of society,”

An examination of these definitions brings forth the following central idea on

economics.

“Economics is a science which studies how scarce resources are optimally allocated
among unlimited wants / uses so as to derive maximum satisfaction.”

Classification of Economics

The subject matter of economies has been divided into two parts – Micro Economics
and Macro Economics. Ragner Frisch was the first to use the terms ‘micro’ and
macro’ in economics in 1933.

Micro Economics

Micro Economics: The term ‘micro economics’ has been derived from a Greek word
‘mikros’ meaning ‘small’. Thus, Microeconomics is the study of economic actions and
behaviour of individuals units and small groups. In other words, in Micro-Economics,
we make a microscopic study of the economy. The determination of equilibrium
output of the firm or industry. The wages of a particular type of labour, the price of a
particular commodity are some of the fields of micro-economics theory. Thus, the
theory of product pricing and the theory of factor pricing (theory of distribution) fall
within the domain of micro-economics,

MICRO ECONOMIC THEORY

Product Pricing Factor Pricing

Theory of
Economic
Welfare

Theory of Demand
Theory of Production & Cost

Wages Rent Interest Profits

MACRO ECONOMICS:-

The term ‘Macro Economics’ has been derived from the Greek Word ‘Makros’
meaning ‘large’. Thus, Macro economics is a study of economics as a whole. It is the
study of aggregates such as total employment, the National Income, the general
price level of the economy. Therefore, it is known as “Aggregative Economics” as it
analyses and establishes the functional relationship between these large
aggregates.

Prof Boulding has rightly remarked, “Macro-economic deals not with individual’s
quantities but with the aggregates of these quantities; not with individual income but
with the National Income; not with individual prices but with the Price level; not with
individual outputs but with the National Output.”

Macro economics is also known as the “Theory of income and employment, or

simply income analysis. It is concerned with the problems of unemployment,
economic fluctuations, inflation or deflation, international trade and economic growth.

MACRO ECONOMIC THEORY

Theory of Income Theory of general Theory of Economic Macro Theory

& Employment price level & inflation growth of Distribution

Theory of Consumption Theory of Investment

Functions
Difference between Micro and Macro Economics :

SL.NO MICRO ECONOMICS MACRO ECONOMICS

1 It is the study of individual economic units It is the study of economy as a whole

of an economy and its aggregates.

2 It deals with individual income, individual It deals with aggregates like national
prices and individual output, etc. income, general price level and
national output, etc.

3 Its Central problem is price determination Its central problem is determination

and allocation of resources. of level of income and employment.

4 Its main tools are demand and supply of a Its main tools are aggregate demand
particular commodity/factor. and aggregate supply of economy as
a whole.

5 It helps to solve the central problem of what, It helps to solve the central problem of
how and for whom to produce in the economy full employment of resources in the
economy.

6 It discusses how equilibrium of a consumer, a It is concerned with the determination

producer or an industry is attained. of equilibrium level of income and
employment of the economy.

7 Price is the main determinant of Income is the major determinant of

microeconomic problems. macroeconomic problems.

8 Examples : Examples:
1. Individual Income 1. National Income
2. Individual Savings 2. National Savings
3. Price Determination etc. 3. General Price level, etc.
DEMAND
Meaning: In ordinary language, demand for a good refers to desire to buy it. But in
economics mere desire to buy a good is not same as demand for it. Demand for a
good refers to desire to buy backed by willingness to spend and ability to pay for it.

Thus, demand has three ingredients, viz.

1. Desire to buy
2. Willingness to spend
3. Ability to pay

It is to be referred that demand for a good is always at a price and per unit of time.
Therefore, demand for a good can be defined as the quantity demanded of a good at
a given price per unit of time.

Determinants of Demand:
Following are the factors on which demand for a good depends:-
1. Price of the concerned good.
2. Price of related goods, viz. substitutes and complements
Two goods are said to be the substitutes if any one of them can satisfy the wants of
a consumer,

For example-Bread and Rice, Scooter and Motorcycle, Tea and Coffee etc,

Two goods are said to be substituted both of them are needed to satisfy a particular
wants.

Example – Tea and Sugar, Bread and Butter, Scooter and Petrol etc

3. Consumer’s Income
4. Consumer’s taste and performance for the good.
5. Distribution of income
6. Government policy with regard to expenditure and taxation
7. Size and growth of population
8. Expectation of the customers
9. Demonstration effects
10. Social customs and traditions

These factors upon which demand for a good depends are the “Determinants of
demand’.
DEMAND FUNCTION:

Relation between quantity demanded of a good and determinants of demand for that
good is known as demand function.

Using mathematical notation, a demand function can be written as:-

𝑄𝑥𝑑 = 𝑓(𝑃𝑥, 𝑃𝑦, 𝑀, 𝑡 … … … )

Here, 𝑄𝑥𝑑 = quantity demanded (Q.D) of good x

f = functional notation
𝑃𝑥 = Price of good X
𝑃𝑦= Price of good Y
M= Consumer’s Income
t= Consumer’s taste
Out of the several determinants of demand, the following are considered to be
important.

1. Price of the concerned good

2. Price of the related good
3. Consumer’s Income

Thus, demand function can be written as: 𝑸𝒅𝒙 = 𝒇(𝑷𝒙, 𝑷𝒚, 𝑴)

ELASTICITY OF DEMAND

Importance of Elasticity of Demand :

The law of demand gives us only the direction of change in demand due to the
change in price. But law of demand does not give the magnitude or exact percentage
of change, Means if price falls by 5%, whether demand rises exactly by 5% or more
than or less than 5%.

It is the Elasticity of demand, which measures the magnitude or the degree of

change.

What is Elasticity of Demand?

 The term elasticity refers to easy expansion and contraction of an object.

 The degree of responsiveness of demand to a given change in price of the

commodity known as elasticity of demand.
  According to Meyers, “Elasticity of Demand is a measure of the relative
change in the amount purchased in response to any change in price on a
given demand curve.”

Types of Elasticity of Demand

There are three kinds of elasticity of demand, viz.

1. Price elasticity of demand

2. Income elasticity of demand
3. Cross elasticity of demand

Price Elasticity of Demand

Elasticity of demand refers to price elasticity of demand. Price elasticity of demand

refers to the degree of expansion or contraction of demand for a good at a given
proportionate change in its price, other things remaining constant.

Thus, price elasticity of demand:

Formula:
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄.𝐷
 𝑒𝑝 =
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒

𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄.𝐷
−−−−−−−−−−−−−−−−−−−
𝑂𝑟𝑖𝑔𝑖𝑜𝑛𝑎𝑙 𝑄.𝐷
 𝑒𝑝 = 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒
−−−−−−−−−−−−−−−−−−−−
𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑃𝑟𝑖𝑐𝑒

Symbolically :

∆𝑄
𝑄
𝑒𝑝 =
∆𝑃
𝑃
∆𝑄 ∆𝑃
=>𝑒𝑝 =(-) .
𝑄 𝑃
∆𝑄 𝑃
=>𝑒𝑝 =(-) .
∆𝑃 𝑄

Here, negative sign indicates inverse price-demand relationship. Ignoring negative

sign, we can write,
 ∆𝑄 𝑃
|𝑒𝑝 |= .
∆𝑃 𝑄

Using calculus, we can write,

𝑑𝑄 𝑃
|𝑒𝑝 |= .
𝑑𝑃 𝑄

Here P= original price

∆P= change in price
Q= original quantity
∆Q = change in quantity

For example :

Price Per Unit in Rs. Quantity demanded

in units

10 50
8 80

Original price (p) = Rs. 10

Change in price (∆P) = 8-10 = (-2)
Original quantity (Q) = 50
Change in quantity (∆Q) = 80-50=30

𝑃 ∆𝑄
𝑒𝑝 = .
𝑄 ∆𝑃

= 10/50 × 30/(-2)

= 300/(-100) = (-3)

 As price and Quantity Demand are inversely related, hence the price elasticity of
demand is always negative but generally minus sign is ignored.
 And the value of ep is always expressed in terms of the positive number.
 So here ep is 3.
Types of Price elasticity:

There are five types of price elasticity of demand, viz,

1. Perfectly elastic demand (𝑒𝑃 = ∞)

2. Perfectly In-elastic demand (𝑒𝑃 = 0)
3. Unitary elastic demand (𝑒𝑃 = 1)
4. Relatively elastic demand (𝑒𝑃 > 1)
5. Relatively Inelastic demand (𝑒𝑃 < 1)
Perfectly elastic Demand:

Demand for a good is said to be perfectly elastic if a given proportionate change in

its price lead to a change in its Q.D by a very large proportion (or) when a given
change in price produces an infinite change to quantity demanded.

Here value of 𝑒𝑃 is ∞.

Example: Suppose price of a good is Rs.10/- per kg. and its Q.D per month is 5 kg. If
price falls to Rs.9.99, its Q.D rises to 5000 kg.

If price falls to Rs.9.99, its Q.D rises to 5000 Kg.

∆𝑄 𝑃
Here, 𝑒𝑃 = .
∆𝑃 𝑄
4995 10
= .
0.01 5
4995 𝑋 2
= 1
100
=9990 X 100
= 999000…………

In case of perfectly elastic demand, demand curve (PD) is horizontal as shown in

figure-2.

Price P D

O Q R X

Q. D

Perfectly Inelastic Demand: Demand for a good is said to be perfectly inelastic if a

given change in its price leads to no change in its Q.D, Here 𝑒𝑃 = 0

Example : Suppose when price of good X=Rs.5 per Kg, Q.D is 2 Kg per month. If its
price falls to Rs.4, Q.D is also 2 Kg per month.

∆𝑄 𝑃
Here 𝑒𝑃 = .
∆𝑃 𝑄

0 5 0
= . = =0
1 2 2
In case of perfectly inelastic demand, demand curve is vertical as shown in figure-2.

Y D

P2

Price P

P1

O X
M
Q.D

Figure-2
Unitary elastic Demand:

Demand for a good is said to be unitary elastic when a given change in price produces an
equal proportionate change in quantity demanded.

Here, 𝑒𝑃 = 1
Example = Suppose, price of a good falls by 10% and consequently its Q.D rises by 10%, here
10%
𝑒𝑃 = =1
10%

In case of unit elastic demand, demand curve looks like a rectangular hyperbola as shown in
figure-3.

 Here, dD represents the demand curve and PP1 = QQ1

Relatively elastic demand / more elastic demand:-

Demand for good is said to be relatively elastic / more elastic, when a given change in price
produces more than proportionate change in quantity demanded.

Here, 𝑒𝑃 > 1
Example : Suppose, price of a goods fall by 10% and consequently Q.D rises by 20%,

20%
So, 𝑒𝑃 =2>1
10%

In case of relatively elastic demand, demand curve (dD1) is flatter as shown in figure-4.

Here rise in demand Q1Q2 is greater than the fall in price P1P2. (Q1Q2. > P1P2)

Relatively Inelastic demand / less elastic demand:-

Demand for a good is said to be relatively inelastic or less elastic when a given
change in price produces less than proportionate change in quantity demanded (or)
when a change in its price in a given proportion leads to a change in its Q.D in a
smaller proportion.

Here 𝑒𝑃 < 1
Example, Suppose, price of a good falls by 10% and consequently its Q.D rises by
5%.

5% 1
So, 𝑒𝑃 = = = 0.5 < 1
10% 2

In case of Relatively, Inelastic demand, demand curve is steeper as shown in figure-5.

Figure-5

Here fall in price is P1P2 and rise in quantity demanded is Q1Q2. Since Q1Q2. < P1P2, price
elasticity is less than one.

Measurement of Price – elasticity:-

There are four methods of measuring price – elasticity of demand:-
1. Percentage method
2. Total outlay method
3. Point method
4. ARC method

1. Percentage method: In case of percentage method, price elasticity of

demand is measured by the ratio, i.e. percentage change in Q.D of the good
by percentage change in the price.

𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄.𝐷

Thus, 𝑒𝑝 =
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒

𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄. 𝐷
− − − − − − − − − − − − − × 100
𝑂𝑟𝑖𝑔𝑖𝑜𝑛𝑎𝑙 𝑄. 𝐷
𝑒𝑝 =
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒
− − − − − − − − − − − − − × 100
𝑂𝑟𝑖𝑔𝑖𝑜𝑛𝑎𝑙 𝑃𝑟𝑖𝑐𝑒
 2. Total outlay method:

Alfred Marshall has introduced the total outlay method to measure the elasticity of
demand.

Total outlay means total expenditure. Total expenditure on a good can be calculated
by multiplying price with Q.D

Thus, TE = P.Q
TE = Total expenditure
P=Price of the good.
Q=Q.D. of the good.

Other things remaining constant, when price of a good falls, its Q.D rises,
consequently total outlay may rise or may remain constant or may fall.

Taking into account, the effect of fall in price from total outlay, Marshall put forth the
following three proportions:

Proportion-I : If due to fall in price of a good, total outlay increases, 𝑒𝑝 > 1.

Proportion-II : If due to a fall in price of good, total outlay remains constant, 𝑒𝑝 = 1
Proportion-III : If due to fall in price of a good, total outlay decreases, 𝑒𝑝 < 1.

For example :

Price (P) Quantity Total Values of

Cases per unit (Q) in outlay elasticity
in Rs. units (P*Q)in of
Rs. demand
(1) (2) (3) (4) (5)

I 8 3 24 E >1
7 4 28

II 6 5 30 E =1
5 6 30

III 4 7 28 E <1
3 8 24

The table explains 3 different situations basing upon total outlay on the good:
  Case-I : when price falls from Rs. 8 to 7,demand rises from 3 to 4, total outlay
increases from 24 to 28. Here E > 1.

 Case-II : when price falls from Rs. 6 to 5,demand rises from 5 to 6 total outlay

remains constant at Rs. 30. Here E = 1.

 Case-III: when price falls from Rs. 4 to 3, demand rises from 7 to 8, total
outlay increases from 24 to 28. Here E < 1.

Diagram of Total Outlay Method

 Here TEFG is the total outlay curve.

 As price falls, the total outlay curve slopes downwards from T to E. here E>1.

 As price falls further, the total outlay curve became vertical from E to F
indicating constant total outlay. Here E=1.

 From F to G, the total outlay falls and E<1.

3. Point method: Point method is used for measuring price elasticity of demand
when change in price and consequent change in its Q.D is very small. In this case,
price elasticity is measured at a point on a straight line demand curve as shown in
the following figure.
Price elasticity of demand is measured at a point method on a straight line
demand curve:

 In the figure AB is a straight demand curve,

 ep at its midpoint, D = DB/DA=1

 ep at a point below mid-point E=EB/EA= < 1
 ep at a point B= 0/BA=0
 ep at above mid-point , C=CB/CA= >1
 ep at A= AB/0= ∞
𝒆𝑷 at different points in a convex demand curve:-
  Here DD’ is a convex demand curve, if we want to measures, at a point in
such demand curve, we have to draw a tangent at that point to the curve.

 Thus, at point R, tt’ is the tangent, point R is the ratio of lower segment (Rt’) to
upper segment (Rt) of that tangent.

 Thus, at point R= Rt’

Rt

4. Arc Method: Arc method is used for measuring price elasticity when change in
price of a good and consequent change in its Q.D is very large. This method of
measurement of 𝑒𝑃 is shown in following figure:

Here, dD is the convex demand curve, corresponding to point A on dD, OP is the

price and OQ is the Q.D, corresponding to point B on it. 𝑂𝑃1 is the price and OR is
the Q.D, since A and B are lying at a distance from each other, 𝑃𝑃1 and QR
represent large changes in price and Q.D respectively. In this case, 𝑒𝑃 is measured
over the arc AB.

∆𝑄 𝑃
It is known that :𝑒𝑃 = ∆𝑃 .𝑄, in case of arc method, in place of original price (P), we
𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑝𝑟𝑖𝑐𝑒+𝑛𝑒𝑤 𝑝𝑟𝑖𝑐𝑒
have to substitute, ( )
2

Similarly, in place of original quantity (Q),

𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦+𝑛𝑒𝑤 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
we have to substitute,( )
2

As a result, formula for measuring 𝑒𝑃 by Arc method would be:-

 𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑝𝑟𝑖𝑐𝑒+𝑛𝑒𝑤 𝑝𝑟𝑖𝑐𝑒
∆𝑄 2
𝑒𝑃 = . 𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦+𝑛𝑒𝑤 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
∆𝑃
2

∆𝑄 (𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑝𝑟𝑖𝑐𝑒+𝑛𝑒𝑤 𝑝𝑟𝑖𝑐𝑒)

=> 𝑒𝑃 = .
∆𝑃 (𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦+𝑛𝑒𝑤 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦)

∆𝑄 (𝑃+𝑃1 )
=> 𝑒𝑃 = . ,
∆𝑃 (𝑄+𝑄1 )

Where, P=Original Price

𝑃1 =New Price
Q=Original Q.D
𝑄1=New Q.D
P=Change in price
Q=Change in Q.D
𝑄𝑅 (𝑂𝑃+𝑂𝑃 )
In terms of figure-7, 𝑒𝑃 over arc AB=𝑃𝑃 . (𝑂𝑄+𝑂𝑅 1 )
1

INCOME ELASTICITY OF DEMAND

It refers to the degree of responsiveness of quantity demanded of a good at a given

proportionate change in the income of consumers, other things remaining constant.
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄.𝐷 𝑜𝑓 𝑔𝑜𝑜𝑑
Thus, 𝑒𝑖 =
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐶𝑜𝑛𝑠𝑢𝑚𝑒𝑟 ′ 𝐼𝑛𝑐𝑜𝑚𝑒

∆𝑄
𝑄
=>𝑒𝑖 = ∆𝑀
𝑀

∆𝑄 𝑀
=>𝑒𝑖 = .
𝑄 ∆𝑀

∆𝑄 𝑀
=>𝑒𝑖 = . --------------(1)
∆𝑀 𝑄

Here Q=Original Q.D

∆Q=Change in Q.D
M=Original income
∆M=Change in Income

 Income elasticity of demand can also be defined as the degree of

responsiveness of expenditure on good due to a given proportionate change
in consumer’s income.
 Expenditure is equal to the quantity purchased of the good(Q) multiplied by
the price of the good(P).
 [E= P × Q]

Multiplying price of a good (P) in both numerator and denominator in the above
expression, we get:-
∆𝑄 𝑀 𝑃
𝑒𝑖 = . .
∆𝑀 𝑄 𝑃

(∆𝑄.𝑃).𝑀
=>𝑒𝑖 =
∆𝑀.(𝑄.𝑃)

𝐶ℎ𝑎𝑔𝑒 𝑖𝑛 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒.𝑀
=>𝑒𝑖 =
∆𝑀.𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒

∆𝐸.𝑀
=>𝑒𝑖 = - - - - - - - - (2)
∆𝑀.𝐸

Here E=Original expenditure

∆𝐸=Change in expenditure
Cross Elasticity of Demand:

It refers to the degree of responsiveness of demand for a good (X) to a given

proportionate change in the price of a related good (Y), other things such as price of
a good X and consumers income remaining constant.
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄.𝐷 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑋
Thus, cross elasticity of demand, 𝑒𝑒 =
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑌

Using mathematical notation, it can be written as :

∆𝑄𝑥
𝑄𝑥
𝑒𝑒 =
∆𝑃𝑦
𝑃𝑦
∆𝑄𝑥 ∆𝑃𝑦
=>𝑒𝑒 = .
𝑄𝑥 𝑃𝑦

∆𝑄𝑥 𝑃𝑦
=>𝑒𝑒 = ∆𝑃𝑦 . 𝑄𝑥

Cross Elasticity of demand and Nature of relation between two goods:

Sign (+ve or –ve) and magnitude of cross elasticity of demand reveal the nature of
relationship between two goods. If 𝑒𝑒 is –ve, two goods are complementary. If 𝑒𝑒 =
0, two goods are not related to each other.

If 𝑒𝑒 > 0 (+𝑣𝑒), two goods are substitute. However, if the value of cross elasticity of
demand is positive, but very small, two goods are imperfect substitutes.
But if the value of cross elasticity is positive and very large (∞), two goods are
perfect substitutes.

Case-I : Case of Complementary goods:

When two goods say X and Y are complementary, 𝑒𝑒 between them is negative (-
ve). Two goods say X and Y are said to be complementary if both are needed to
satisfy a particular want. In this case, if price of Y falls, price of X remains constant,
Q.D of Y will rise and at the same time Q.D of X will also rise.

Example:

Suppose, when Py=Rs.40, Qx=100 units per year, if Py falls to Rs.35, Qx rises to
120 units per year.
∆𝑄𝑥 𝑃𝑦
Here, 𝑒𝑒 = ∆𝑃𝑦 . 𝑄𝑥

+20 40
= −5
. 100

−8
= = −1.6 < 0
5

Thus, in case of complementary goods, cross elasticity of demand is negative.

Case-II : Case of unrelated goods;

When two goods say X and Y are not related, cross elasticity of demand between
them is zero.

If two goods X and Y are unrelated, with fall in price of good Y, there is no change in
Q.D of good X.

Example : When Py=Rs.50, Qx=10 units per month, If Py falls to Rs.40, Qx remains
same at 10 units.
∆𝑄𝑥 𝑃𝑦
Hence, 𝑒𝑒 = ∆𝑃𝑦 . 𝑄𝑥

0 50 0
= −10 . 10 = −100 = 0

Thus, when two goods are unrelated, cross elasticity of demand between them is
zero.

Case-III – Case of elasticity of goods:

When two goods say X and Y are substitutes, cross elasticity between them is
greater than zero (or positive).

However, two goods may be imperfect substitute or perfect substitutes of each other.
(a) Case of Imperfect substitute:

When two goods, X and Y are imperfect substitutes, with fall in price of good Y, Q.D
of X does not fall so much.

Example: When price of Y is Rs.20/- per Kg, Q.D of X is 2 kg. per month.

If price of Y falls to Rs.15 per Kg., Q.D of X is 1.5 kg. per month.
∆𝑄𝑥 𝑃𝑦
Here, 𝑒𝑒 = ∆𝑃𝑦 . 𝑄𝑥

0.5 20 10
= − −5 . = 10 = 1
2

Here, magnitude of 𝑒𝑒 is very small (1), thus when two goods are imperfect,
substitutes, 𝑒𝑒 𝑏𝑒𝑡𝑤𝑒𝑒𝑛 𝑡ℎ𝑒𝑚 𝑖𝑠 𝑝𝑜𝑠𝑖𝑡𝑖𝑣𝑒 𝑏𝑢𝑡 𝑠𝑚𝑎𝑙𝑙.

(b) Case of perfect substitutes:

When two goods, X and Y are perfect substitutes of each other, they are regarded as
one and the same. If there is slight fall in price of good Y, Q.D of good X will fall to
zero.

Example : Suppose, when price of Y=Rs.50/-, Q.D of X=5 Kg.

If price of Y falls to Rs.49.99, then Q.D of X is 0.

∆𝑄𝑥 𝑃𝑦
Here 𝑒𝑒 = ∆𝑃𝑦 . 𝑄𝑥

−5 50
= 𝑒𝑒 = −0.01 . 5

50 50
= 𝑒𝑒 = 0.01 . 1/100=5000 ……………. ∞

Thus, when two goods are perfect, substitutes, cross elasticity of demand between
them is infinitely large. However, in real world perfect substitutes are hardly found.

DETERMINANTS OF ELASTICITY OF DEMAND

The major factors affecting elasticity of demand are :

1. Nature of a commodity: According to the nature of satisfaction, the goods give,

they may be classified into luxury, comfort or necessary goods. In general, luxury
and comfort goods are price elastic, while necessary goods are price inelastic.

Example: The demand for food grains, cloth, salt etc. is generally inelastic while that
for furniture, car, etc are elastic.

2. Availability of substitutes: Where there exists a close substitute in the relevant

price range of commodities such as tea, coffee or beverages such as soft drinks,
having a wide range of substitute, demand will tend to be elastic. But in respect of
commodities having no substitutes such as onion, potatoes, salt, etc are the demand
in highly inelastic.

3. Number of Uses: Generally commodities having several uses have elastic

demand such as milk, wood etc than those which have single use such as medicines
etc. single use commodities have an inelastic demand.

4. Price: Generally demand for a very high priced good and cheap goods is very
elastic. Very high priced goods are demanded by the rich people in the society and
hence their demand is not much affected by the change in the price. Similarly, the
changes in price of a very cheap good such as salt will not have much affection their
demand because a very small part of income is spent on such commodities.

5. Consumer’s Income: Generally, larger the income, the demand for overall
commodities tends to be relatively inelastic. The demand pattern of a millionaire is
rarely affected even by significant price changes. Similarly, the re-distribution of
income in favour of low-income people may tend to make demand for some goods
relatively elastic.

6. Time period: In short period, demand in general will be less elastic, while in the
long period, it becomes more elastic. This is because it takes some time for the news
of a price change to become known to all the buyers.

7. Postponement: Demand is more elastic for goods the use of which can be
postponed.

For example: if the price of the good rises, its consumption can be postponed. The
demand for gold is therefore, elastic. Demand is in elastic for those goods the use of
which is urgent and therefore, cannot be postponed. The use of medicine cannot be
put off. Hence, the demand for medicine is inelastic.

8. Influence of Diminishing Marginal Utility: Law of diminishing marginal utility

states that “as the stock of a commodity rises, its marginal utility falls”. That means,
Utility falls when we consume more and more units but not in a uniform way. In case
utility falls rapidly, it means that the consumer has no other near substitutes. As a
result, demand is inelastic. On the other hand, if the utility falls slowly, demand for
such commodity could be elastic.

9. Fashion, tastes and preferences:

Most fashionable and branded goods have inelastic demand, as the consumers will
continue to buy the preferred brand even if there is a significant increase in its price.
Similarly product to which consumers are addicted, also have inelastic demand. So
in short fashion, taste and preferences play an important role in determining the
elasticity of demand.
10. Joint demand : In the event of a good being jointly demanded such as car and
petrol, the elasticity of demand the second good depends on the elasticity of main
good. For example, if the demand for car is inelastic, the demand for petrol will also
be inelastic.

11. Proportion of expenditure : the demand for a good on which a small proportion
of income is spent is inelastic. Salt, match box and soap etc are the examples. On
the contrary, the demand for such commodities are where a major part of income is
spent is elastic like the demand for comforts and luxuries.

12.