INTRODUCTION

The Law of Demand explains only the direction of change in demand for a commodity as a result of change in price. Thus, the law of demand does not explain the degree of change in demand.

ELASTICITY OF DEMAND
Elasticity measures the responsiveness of one variable to the variations of another variable. Thus, the elasticity of x with respect to y, elasticity defined as E =% change in x / % change in y DEMAND ELASTICITY- it not only tells us that consumers demand responds to price changes but also the degree of responsiveness of consumers to a price change.

Figure shows two Demand curves let Da be the demand for cheese in switzerland and Db be the demand for cheese in England. At price $10 quantity demanded in both countries is 60. When price falls $10 to $5 quantity demanded increased more in England than Switzerland. We can say demand for cheese is more elastic in England than Switzerland. Elasticity of demand is important as indicator of how total revenueTR changes when a change in P induced changes in Q along the demand curve. Total revenue = Price x Quantity.Total revenue received by the firms are equal to total spending by consumers.

INTRODUCTION TO ELASTICITY OF DEMAND In Laymans Language or in general sense, Elasticity of demand is the rate at which demand changes due to change in price.

Elasticity of demand measures the degree of change in demand of a commodity in response to a change in the price of the commodity, or change in the income of the consumer or change in the prices of related goods.

Definition
According to Dr. Marshall, Elasticity of demand may be defined as per the percentage change in the quantity demanded divided by the percentage change in the price.

CLASSIFICATION OF DEMAND CURVES ACCORDING TO THEIR ELATICITIES

Depending on how total revenue changes, when price changes we can clasify all demand curve in five categories: 1 PERFECTLY INELASTIC DEMAND CURVES 2 INELSTIC DEMAND CURVES 3 UNITARY ELASTIC DEMAND CURVES 4 ELASTIC DEMAND CURVES 5 PERFECTLY ELASTIC DEMAND CURVES

Fig. A- PERFECTLT INELASTIC DEMAND CURVEDemand curve implies that when price decrease the total revenue decrease and vice versa. All such demand curve are suppose to have an elsticity coefficient Ed = 0. Elsticity coefficient is a number describing the elasticity of a demand curve. E.g. life saving drugs.

Fig. C- PERFECTLY ELASTIC DEMAND CURVE- When prices falls the quantity demand increases infinitely, on the other handwhen price rises the quantity demand falls to zero and total revenue also falls to zero. Demand is infinitely responsive to price changes.When price decrease total revenue increased and viceversa. Elsticity coefficient Ed = infinity. Fig. B- Represents mid point- when prices decrease total revenue remajns unaffected. Such demand curve is said to be UNITARY ELASTIC. Price increase or decrease total revenue remains constant. E.g. amount allcated for magzine. Ed = 1

Demand curves which have an elasticity coefficient between 0 and 1 are called inelstic or relatively inelstic. Da curve is an example of a relatively inelastic curve. When the price falls, the quantity demand expands but total revenue still

Da curve is example of a relarively inelastic demand curve. Such curve has an elastic coefficient between 1 and 150. When price decrease total revenue increase and viceversa. Believe it or not, in the real world 99.99% of the demand curves are either relatively elstic or relatively inelastic.

NUMERICAL MEASUREMENT OF ELSTICITY

Elasticity coefficient (Ed ) = % change in quantity demanded / % change in price Ed = Q1-Q0 / Q0 / P1-P0 / P0 P0 =original price, P1 =new price, Q0 =original quantity demanded, Q1 = new quantity demanded

Demand is elastic if a given % change in price results in a larger % change in quantity demanded. E.g. 2% decline in price results in a large %4increase in demand then called elastic. If 3% decline in price results 1% increase in demand then called inelastic. The border line case of unitary elasticity which separate elasticity and inelasticity of demands occurs where change % in price is equal to change % in demand.

COMPUTATION OF ELASTICITY COEFFICIENTS

A ARC &POINT ELASTICITY
We want to calculate elasticity when price changes from Rs.4 to Rs.3 per unit
Price of commodity Quantity x (Rs.) demanded of commodity x (kg.) 4 3 2 1 16 25 30 34

When price changes Rs.4 to Rs.3, P =Rs.3 Rs.4 = Rs.-1 (i.e. price changes is negative since it is a price fall ). The change in quantity demanded is Q : 25 16 = 9 (quantity change is positive ) E = Q / Q / P / P = 9 / 16 / -1 / 4 = -2.25 Now if we calculate the elasticity when price increases from Rs.3 to Rs.4 we find that for the same stretch of the demand curve, elasticity would be different. E = Q / Q / P / P = -9 / 25 / +1 / 3 = - 1.08 We got two answers for same stretch. This is known as point elasticities. Two answers differ because our initial quantity demanded and price have been different. To get rid of this problem created by the choice of the initial situations, we take air thematic mean of two quantities . q and t he mean of two prices p. This gives us an arc elasticity ARC. E = Q / Q0 +Q1 X P0 +P1 / P Where Q0 & Q1 are the two quantities corresponding to the two points on the demand curve, similarlyP0 & P1 are the two prices.

Elasticity of demand can be mainly of three types : 1. Price Elasticity of Demand 2. Income Elasticity of Demand 3. Cross Elasticity of Demand

PRICE ELASTICITY OF DEMAND Price elasticity of demand is commonly called the elasticity of demand. This is because price is the most changeable factor influencing demand.

Definition :
The elasticity of demand for a commodity is the rate at which quantity bought changes as the price changes. A.K. Cairncross Elasticity of demand/PE = (-) Proportionate/Percentage change in Demand Proportionate/Percentage change in Price

Degrees of Price Elasticity of Demand

1. 2. 3. 4. 5. There are five degrees of price elasticity of demand : Perfectly elastic demand Completely/Perfectly Inelastic demand Unitary Elastic Demand More elastic demand Less elastic demand

Measurement of Price Elasticity of Demand

Whether Price elasticity of demand is (1) Unitary or (2) Greater than Unitary or (3) Less than Unitary, is known by its measurement. There are five methods of measuring price elasticity of demand : Proportionate Method Point Elasticity Method Arc Elasticity Method Revenue Method

(1) (2) (3) (4)

Percentage Method or Proportionate Method or flux Method

This method was propounded by Dr. flux. According to this method the elasticity of demand can be measured with the help of the following formula. Ed=(-) Q1- Q Q= Initial Quantity demanded Q Q1= Changed demand P1-P P= Initial Price of the good P P1= Changed Price

Point Method
This method is suggested by Dr.Marshall which is used to find out the elasticity of demand at a particular point on a demand curve. Point method for measuring price elasticity of demand is also known as Geometrical Method. According to this method point elasticity can be measured with the help of the following formula. E at point = Lower Sector of Demand Curve Upper Sector of Demand Curve

If (i) Lower Sector > Upper Sector ; E>1 (ii) Lower Sector = Upper Sector ; E = 1 (iii) Lower Sector < Upper Sector; E<1 With the help of this formula, price elasticity of demand can be measured on two types of demand curves (a) In case of Linear Demand Curve (b) In case of Non-linear or Curvi-Linear Demand Curve.

NON-linear Demand Curve

When demand curve is non-linear, then to know the elasticity of demand at any point located on it, a tangent is so drawn as to touch this point. Consequently, this point will divide the tangent into two parts. Lower segment of the tangent is then divided by the upper segment.

Arc Method
In this method, we make use of the mid points between the old and the new figures in the case of both price and demand. This method of measurement is known as Arc elasticity. In the words of Leftwitch, When elasticity is computed between two separate points on a curve, the concept is called arc elasticity.

Revenue Method
Sale proceeds that a firm obtains by selling its products is called its revenue. Price elasticity of demand is also measured with the help of average and marginal revenue, as per the following formula : E= A A-M E=Price elasticity of demand, A=Average Revenue, M=Marginal Revenue

When MR is +ve, Ed on the corresponding point of AR curve is more than unity. When MR is ve, Ed on the corresponding point of AR curve is Less than unity. When MR is 0, Ed on the corresponding point of AR curve is equal to unity.

Factors determining the Price Elasticity of Demand

Nature of the commodity Availability of Substitutes Income of the customer Habit of the Consumer Proportion of income spent on a commodity Price-Level

Time

INCOME ELASTICITY OF DEMAND

Meaning of Income elasticity of demand: Income elasticity of demand is the rate at which quantity bought changes, as a result of change in the income of the consumer, other things being equal.

Definition
According to Watson, Income elasticity of demand means the ratio of the percentage change in the quantity demanded to the percentage change in income. Measurement of Income Elasticity Ey = Proportionate change in Demand Proportionate change in Income

Illustration
Suppose a consumer's income is Rs.1000 and he purchases 10 kgs. of sugar. If income goes up to Rs.1100 he is prepared to buy 12 kgs. Calculate income elasticity of sugar. Q2-Q1 12 - 10 Q2+Q1 12 + 10 ey = ---------- = -------------------Y2-Y1 1100 - 1000 Y2+Y1 1100 + 1000 = 2 -:- 100 = 1 x 21 22 2100 11 1 = 21 = 1.99 11 Demand for sugar is income elastic

Kinds of Income Elasticity of Demand

Income elasticity of demand is of three types Positive Income Elasticity of Demand : o When the amount demanded of a commodity increases with increase in income of the consumer and decreases with decrease in income, the income elasticity of demand is positive. o Income elasticity of demand is positive in case of Normal Goods.

Positive Income elasticity of demand

D

P A Income D

B S Quantity Demanded

Positive Income elasticity of demand

Income Elasticity Equal to Unity or One Income Elasticity Greater Than Unity Or One Income Elasticity Less Than Unity or One

Negative Income Elasticity of Demand

When the amount demanded of a commodity diminishes with an increase in the income of the consumer and increases with a fall in income, the income elasticity of demand is said to be negative. Income elasticity of demand is negative in case of Inferior goods, known as Giffen Goods. Example: Cheaper Cars, Travelling by bus

Negative Income elasticity of demand

Price P

Total Revenue
B S

Quantity Demanded (000s)

Zero Income Elasticity of Demand

When the demand for a commodity does not respond to changes in income of the consumer, the income elasticity of demand is zero. Generally, goods which are very cheap and important like salt, postcard, newspaper, candles, buttons, kerosene etc., the demand is completely income inelastic. Symbolically, it is represented as Ey = 0

Zero Income elasticity of demand

Y D

Income
O

D Quantity Demanded

Measurement Of Income Elasticity Of Demand

Income Elasticity Of Demand = Proportionate change in Demand Proportionate change in Income

i.e. q Income Elasticity Of Demand = Q

y 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 = 2,500/- , he purchases 20 units of X, when income = 3,000/- he purchases 25 units of X

Measurement Of Income Elasticity Of Demand

Thus Income Elasticity of Demand q y = Y
Q

= (5/20) + (500/2500) = 1.5 therefore here the IED is 1.5 which is more than one.

Factors Affecting Income Of Demand

Income Itself Only. Price Of the Commodity

Degrees of Income Elasticity of Demand

Income Elasticity of Demand is equal to Unity : If income changes by 100% then if demand also changes by 100 %, thus, Ey = 1 Income Elasticity of Demand is more than Unity : Income elasticity of demand is more than unity when % change in demand is more than % change in income. Ey>1

Income Elasticity of Demand Less than Unity

Income elasticity of demand is less than unity: when proportionate change in demand is less than proportionate change in income. For Ex., if income changes by 100% and demand changes by just 50 % Ey < 1

CROSS ELASTICITY OF DEMAND

Cross elasticity of demand is the rate at which quantity bought of x changes, as a result of change in the price of y commodity, other things being equal. Measurement of Cross Elasticity of Demand Exy = Proportionate change in demand of X Proportionate change in price of Y

Kinds of Cross Elasticity of Demand

Positive Cross Elasticity : With the rise or fall in the price of commodity the quantity demanded of the related commodity increases or decreases accordingly, then the cross elasticity of demand is +ve (or Ec is +ve) Ordinarily, the cross elasticity of demand in case of Substitutes as tea and coffee,

Cross Elasticity of Demand For Y Substitutes

D

Price of Y

D O X

Demand for Y

Negative Cross Elasticity of Demand When with a rise in price of a commodity, the demand for related good decreases, and with a fall in price of a commodity, the demand for other related good increases, then the cross elasticity of demand is said to be ve. O Generally, in case of Complementary Goods like Car and Petrol,

Cross Elasticity of Demand For Complementary Products Y

D

Price of Y

D O Demand for Y X

Zero Cross Elasticity of Demand

When with a change in the prices of a commodity, there is no change in the demand for another commodity; then the cross elasticity of demand is said to be zero. (Ec=0) Generally, Cross Elasticity of demand is said to be 0 when two goods are Independent Goods. For Ex. Change in the price of Butter have no effect on the demand of Petrol.

Cross Elasticity of Demand For Independent / Neutral Products Y

D Price of Y O

Demand for Y

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 Cross Elasticity of Demand

Proportionate change in Demand for product X
Cross Elasticity of Demand = Proportionate change in Price of product Y p y

i.e.

Cross Elasticity of Demand = qx 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 . In demand forecasting Helps in measuring interdependence of price of commodity . Multi product firms use these concept to measure the effect of change in price of one product on the demand of their other product

Importance
Managerial uses of Price elasticity of demand Determination of Price under Monopoly Basis of Price Discrimination Determination of wages Advantage to Finance Minister Determination of Prices of Public utilities Distribution of Burden of Taxation Basis of the Policy of Devaluation

Importance of Income Elasticity of demand

Knowledge of nature of goods Importance in Production Planning Importance of Cross Elasticity of demand Classification of commodities Helpful to firm and Industry