Elasticity of Demand

It measures the extent to which the quantity demanded will rise or fall due to fall or rise in the price of that good or related good or rise or fall in income .

Types of Elasticity of Demand

Price Elasticity of Demand Income Elasticity of Demand Cross Elasticity of Demand Promotional or Advertising Elasticity of Demand

Price Elasticity of Demand

ep =Percentage changes in quantity demanded/ percentage changes in price The quantity demanded decreases when the price increases ,thus this ratio is negative . However the absolute value I usually taken and hence price elasticity of demand is shown as a positive number.

Measurement of price elasticity mathematically

Point Elasticity

ARC Elasticity

Find out ep for a movement from point B to D and D to B

Point A B C Px 8 7 6 Qx 0 1000 2000

D
E F

5
4 3

3000
4000 5000

Answer
B to D= -7 D to B=-1.67 We can avoid different results by using the average of two quantity and two prices which is called Arc method . Then answer would be -3or 3

Price Elasticity Graphically

Measurement of the elasticity over a segment of the demand curve Measurement of the elasticity at a point of the demand curve On a straight downward sloping demand curve elasticity will be different for different points .

Different degree of elasticity

Ep=1 Ep>1 Ep= EP<1 Ep=0 Unitary Elastic Relatively elastic or elastic perfectly Elastic Relatively inelastic or Inelastic Perfectly Inelastic

Price Elasticity , Total Revenue and Total Expenditure

Regardless the slope of the demand curve, as the price of a commodity falls ,the total expenditure of the consumer on the commodity will Rise when ep>1 Remains Unchanged when ep=1 Falls when ep<1

An inelastic demand implies that total revenue and expenditure on a good will increase when price rises and vive versa .

Income Elasticity of Demand

ey=percentage change in Quantity demanded/percentage changes in Income If ey is negative ,good is inferior. If ey is positive good is normal . For normal goods If ey>1 Good is luxury If ey<1 good is necessity

Example
Income Y ($per year ) 8000 12000 16000 20000 24000 28000 32000 Quantity ey 5 10 15 18 20 19 18 Type of good

2 1.5 0.8 0.56 -.30 -.37

Luxury Luxury Necessity Necessity Inferior Inferior

Cross Elasticity of Demand

exy= Percentage change in the amount of good X Purchased / percentage change in the price of good Y If exy is positive ,X and Y are substitutes . If exy is negative , Xand Y are complements .

Example
Commodi Before ty Price Rs /cup Coffee (Y) Tea (X) 4 2 After Quantity Price Units / Rs /cup month 50 6 40 2 Quantity Units / month 30 50

Answer
+ .5 GOODS ARE SUBSTITUTE

Factors determining elasticity of demand

Study yourself

Numerical
Ashoka company manufactures and sells readymade garments , the demand function is Q= 20000 300P The Co. currently sells at the price of Rs 30 per unit Answer 1. Compute the point price elasticity of demand at the current price . 2. If the objective of the Co. is to increase total revenue , should the price be increased or decreased ? 3. Compute the arc price elasticity for a price decrease from Rs 30 to Rs 20.

Using only the total expenditure Criteria determine if these demand curves are elastic or inelastic
P
Qx

6
100

5
110

4
120

3
150

1
300

Qz

100

150

225

325

1100

Price Elasticity of Supply and factors determining it

Study Yourself

 The Reynolds company is trying to capitalize on the booming market for ballpoint pens .It has been selling 500 numbers of ballpoint pen per week at Rs 15.00 each. However it is considering lowering the price to Rs 12.00. The outside consultants they hired estimated that its price elasticity of demand to be - 5 over this price range .

A. What would be the new quantity sold if the price were lowered to Rs 12.00?

B.What would be the level of the new revenue ?

C. What additional information does Reynolds Company needs to know before it can determine whether or not a price decrease to Rs 12.00 will increase its profits ?

 D. Suppose Reynolds's nearest competitor lowers its price from Rs 12.00 to Rs 9.00 per Ball point pen . If the cross elasticity is 0.24,what will be the effect of the competitor's price reduction non Reynolds Companys quantity sold?

1750 21000 Cost information 1633.978 or approximately 1634

The following table gives the estimated price ,cross, and income elasticities for selected commodities in USA or UK Required Indicate from the price elasticity if the demand is elastic or inelastic, From the cross elasticity if the commodities are substitutes or complements and from income elasticity whether the commodity is a luxury , necessity or an inferior good Indicate in the change in the amount purchased of each good if the commodity price or the consumers income rose by 10 %

Price elasticity of demand Commodity Beef Potatoes Sugar Electricity ep 0.92 0.31 0.31 1.20

Restaurant Meal 2.27

CLASS OF 2006

Income elasticity of demand Commodity Butter Margarine ey 0.42 -0.20

Meat
Electricity

0.35
0.20

Restaurant Meal 1. 48

Cross elasticity of demand

Commodity Beef, pork Butter , Margarine Cheese , Butter exy 0.28 0.67 - 0.61

Sugar , Fruits

- 0.28

Electricity, Natural Gas 0. 20

Demand schedule for product X for the last five years is given below: Year
1 2 3 4 5

Px
10 10 10 10 15

Qx
1000 950 1050 110 900

Py
9 10 9 9 9

15000 50000 15000 50000 16000 50000 15000 60000 15000 50000

Required

Using arc elasticity estimate price, income and promotional elasticities of demand Based on the above answer ,comment on i. The nature of the product X ii. The relation between product X and Y iii. The effect of an increase in the price of product X on total revenue

Answers
i. Price elasticity: 0. 263 Cross Elasticity : - 0.487 Income elasticity : 0.756 Promotional elasticity : 0.524 ey is positive good is normal , but ep is les than one so good is necessity ii. AS exy is negative goods X and Y are complementary goods iii. If price is increased total revenue will increase as ep is inelastic

Moonlight ,a domestic appliance manufacturer, has estimated its demand function for its fully automatic washing machine to be
Q= 166000- 100Pm+ 75Pc +2.5Y+0.02A- 200C Q=Demand for Moonlight fully automatic washing machine PM =Price of Moonlight Washing machine Pc= Price of a competing brand Y= Per capita income of the country A= Annual promotional expenditure on this model by Moonlight C= Operating cost per load of wash for this model

The current values for the variables are as follows :

Pm=Rs 10000 Pc = Rs 11000 Y= Rs 20000 A= Rs 500000 C=Rs 5 What are the values of price and cross elasticities of demand for Moonlights Washing Machine

Answers
- 20 and 16.5 respectively