Elasticity of demand

Elasticity's of demand

• Elasticity :• It is a general concept that can be used to quantify the

response in one variable when another variable changes.• The degree of responsiveness of demand to the change in

its determinants is called elasticity of demand. It explains the extent of change in quantity demanded because of a given change in the other determining factors.

• .

Measurement of elasticity

• The elasticity is measured in the following ways:

• A. perfectly elastic demand.• b . Perfectly inelastic demand.• C. relatively elastic demand• D. relatively inelastic demand.• f. unity elasticity.

Perfectly Elastic andPerfectly Inelastic Demand Curves

• Relatively inelastic demand ed < 1 e.g., telephone services, petrol etc.

• Elastic or unitary elastic ed = 1

• Relatively elastic ed > 1 groceries, vegetables etc.,

• Perfectly elastic demand: • when any quantity can be sold at a given

price, and when there is no need to reduce price, the demand is said to be perfectly elastic.

• Examples of perfectly elastic demand:• Items that perfect competition. • Unbranded spices, dry fruits, coffee beans

• b . Perfectly inelastic demand:• when a significant degree of change in price

leads to little or no change in the quantity demanded, then the elasticity is said to be perfectly inelastic.

• In other words the demand is said to be perfectly inelastic when there is no change in the quantity demanded even though there is a big change in price.

• Unit elasticity:• the elasticity in demand is said to be unity

when the change in demand is equal to the change in price.

• Relatetively elastic demand:• The demand is said to be relatively elastic

when the change in demand is more then the change in price. In other words the extent of increase in the quantity demanded is greater than the extent of fall in the price.

• ep > 1

• Examples of such goods are luxuries.

• Relatively inelastic demand: • The demand is said to be relatively inelastic

when the change in demand is less than the change in the price

• Examples of perfectly elastic demand:• Items that perfect competition. • Unbranded spices, dry fruits, coffee beans

Types of elasticity

• the following are the four types of elasticity of demand:

• 1. price elasticity of demand.• Income elasticity of demand.• Cross elasticity of demand.• Advertising elasticity of demand.

Price Elasticity of Demand• A popular measure of elasticity isA popular measure of elasticity is price elasticity price elasticity

of demand of demand measures the responsiveness of measures the responsiveness of demand for a commodity to the changes in the demand for a commodity to the changes in the price of a product.price of a product.

• It is the percentage change in demand as a result It is the percentage change in demand as a result of one percent change in the price of the of one percent change in the price of the commoditycommodity

% ch an g e in q u an tity d em an d ed x 1 0 0 %2Q Q

Q1

1

Price Elasticity of Demand

p rice e las tic ity o f d em an d % ch an g e in q u an tity d em an d ed

ch an g e in p rice

%

• The value of price elasticity is always negative, but it is stated in absolute terms

• The elasticity can be measured between any two points on a demand curve ( called arc elasticity) or at a point (point elasticity)

Calculating Elasticities

% ch an g e in p rice x 1 0 0 %2P P

P1

1

Income elasticity of demand

• Income elasticity of demand refers to the quantity demanded of a commodity in response to a given change in income of the consumer.

• Income elasticity is normally positive, which indicates that the consumer tends to buy more and more with every increase in income.

• Income elasticity of demand=• proportionate change in quantity demanded

for product x• proportionate change in income.• The seme is expressed as• Edi= Q2-Q1/Q1 i2-i1/i1 •

• Where q1 is the quantity demanded before change, q2 is quantity demanded after change

• Where I1 is income before change and I2 is the income after change,

cross elasticity of demand

• cross elasticity of demand refers to the quantity demanded of a commodity in response to a change in price of the related good which may be substitute or complement.

• Cross elasticity of demand= proportionate change in quantity demanded for product x__________________________________

• Proportionate change in price of product Y,

Advertising elasticity of demand

• Advertising elasticity of demand refers to increase in the sales revenue because of change in the advertising expenditure.

• In other words there is direct relationship between the amount of money spent on advertising and its impact on sales.

• Advertising elasticity is always positive.

Factors governing elasticity of demand

• Nature of product• Time frame• Degree of postponement• Number of alternative uses• Tastes and preferences of the consumer.• availability of close substitute• In case of complementary or joint foods

• Level of prices• Availability of subsidies• Expectation of prices• Durability of the product• Government policy

Significance of elasticity of demand

• To fix the prices of factors of production• To fix the prices of goods and services

provided rendered• To formulate or revise government policies• to forecast demand• to plan the level of output and price.

Methods to measure elasticity of demand

• 1. point elasticity • 2. arc elasticity.• Point elasticity: A demand curve does not

have the same elasticity throughout its entire length. In general, elasticity differs at different points on a given demand curve. However this does not hold good in the following three cases: a. perfectly elastic b. perfectly inelastic c. unity elasticity.

• The demand curves in each of these cases possess a single elasticity throughout its entire length.

• Arc elasticity:• arc elasticity measures the average

responsiveness to price change .