ELASTICITY OF DEMAND

Utsav Gahtori BBA I 639

MEANING OF ELASTICITY OF DEMAND

The elasticity of demand measures the responsiveness of the quantity demanded of a good, to change in its prices, price of other goods and change in consumers income. Thus, Elasticity measures the extent to which demand will change.

TYPES OF ELASTICITY OF DEMAND

Price Elasticity Of Demand

Income Elasticity Of Demand

Cross Elasticity Of Demand

PRICE ELASTICITY OF DEMAND

Price elasticity of demand is the ratio of the percentage change in the quantity demanded of a commodity to a percentage change in its price.

PEd = (-) % change in quantity demanded % change in price

WHY (-) SIGN?

Since there is an inverse relationship between price and quantity demanded of a good. Thus the price elasticity of demand is always negative

Thats why elasticity of demand is expressed by minus(-) sign.

DEGREES OF PRICE ELASTICITY OF DEMAND

The concept of elasticity of demand is divided into five degrees which are: Perfectly Elastic Perfectly Inelastic Less than Unitary Elastic Greater then Unitary Elastic or ELASTIC

Less than Unitary Elastic or INELASTIC

PERFECTLY ELASTIC DEMAND

A little change in price causes an infinite change in demand.

A Perfectly Elastic Demand Curve

ED =
Price

120

150
Quantity

PERFECTLY INELASTIC DEMAND

Change in price of a commodity produces no change in the quantity demanded.

Perfectly inelastic demand curve

Price

4 3

ED = 0
120
Quantity

UNITARY ELASTIC DEMAND

The % change in price produces an equal % change in demand.

A Unit Elastic Demand Curve

ED =1

2 0 120 150

Quantity demand

GREATER THAN UNITARY ELASTIC OR ELASTIC

DEMAND

% change in demand is more than the % change in price of the commodity.

A More Elastic Demand Curve
4

Price

ED > 1
D

120

160
Quantity

LESS THAN UNITARY ELASTIC OR INELASTIC

DEMAND

% change in demand is less than the % change in the price of the commodity.
A More Inelastic Demand Curve
4
Price 3

ED < 1
D 120 140 Quantity

MEASUREMENT OF PRICE ELASTICITY OF

DEMAND

There are five methods of measuring price elasticity of demand:

Total expenditure method Proportionate method Point elasticity method Arc elasticity method Revenue method

TOTAL EXPENDITURE METHOD

In order to measure the elasticity of demand it is essential to know how much and in what direction the total expenditure changes as a result of change in the price of a good.

If total expenditure remains same, no matter price rises or falls, then the elasticity of demand is UNITARY. If, due to fall in price, TE goes up and due to rise in price TE goes down, then elasticity of demand is GREATER THAN UNITARY.

If, due to fall in price TE goes down and due to rise in price TE goes up, then elasticity of demand is LESS THAN UNITARY.
Price 6 5 6 5 6 5 Qty. 10 15 10 12 10 11 TE 60 75 60 60 60 55 PEd >1 =1 <1

TOTAL OUTLAY METHOD

T A

R price N

Ed>1 B

Ed=1

M P O E D

C Ed<1

Total expenditure

PROPORTIONATE OR PERCENTAGE METHOD

Ed= (-) Proportionate change in demand for good-X

Proportionate change in price of good-X OR Change in qty. demanded Initial demand Change in price Initial Price

Ed= (-)

Q1-Q Q =(-) Q = (-) Q P1- P P P P

Ed=(-) Q P = Q * P Q P Q P Ed= (-) P x Q Q P

POINT ELASTICITY OF METHOD

It refers to price elasticity of demand at any point on the demand curve. Price elasticity of demand is different a different points on a demand curve. Accordingly, price elasticity at every point on a given demand curve is measured separately.

PEd=lower portion of demand curve upper portion of demand curve

ELASTICITY ALONG A DEMAND CURVE

10 9 8 7 6 5

Ed = Ed > 1

Elasticity declines along demand curve as we move toward the quantity axis

Price

Ed = 1
Ed < 1 Ed = 0
1 2 3 4 5 6 7 8 9 10 Quantity

4 3 2 1

ARC ELASTICITY METHOD

In case of point elasticity method, elasticity can be measured only if there is an infinitely small change in price and the quantity demanded.

This method is applied when there is huge change in the price and the quantity demanded.

D P P1 P2 A

ARC

B
C D

Price

Q Qty.

Q1

Q2

FACTORS DETERMINING THE PRICE

ELASTICITY OF DEMAND Nature of the commodity: Goods are divided into three categories, i.e., 1) Necessaries: demand is inelastic. 2) Comforts: price elasticity is unitary. 3) Luxuries: demand is elastic.

Availability of substitutes: goods having substitutes available like tea and coffee have elastic demand. whereas commodities that do not have any substitutes, e.g. liquor have inelastic demand.

Goods with different uses: goods that can be put to different uses have elastic demand. Like electricity. Postponement of the use: goods whose demand can be postponed have elastic demand. Income of the consumer: people having very high or very low income have inelastic demand. But for a middle income people, demand is elastic. Influence of habit and custom: Demand is inelastic if a consumer is habitual of a good. Proportion of income spent on a commodity:

Price level Time Joint demand Recurrence of demand