ELASTICITY OF DEMAND
The Responsiveness of buyers to a change in the price of a commodity is called as Elasticity of Demand.
It is the rate at which the quantity demanded of a commodity varies with a change in price.
Demand is also effected by the Income of the customers and prices of related goods. So therefore, we have Income Elasticity of Demand (Ey) and Cross Elasticity of Demand (Exy)
TYPES OF ELASTICITY OF DEMAND 1. Price Elasticity of Demand (Ed): It is the ratio of the percentage change in quantity demanded of a product to the percentage change in its price. Ed =
% change in Qd % change in Price
=
q/q p/p
TYPES OF ELASTICITY OF DEMAND 2. Income Elasticity of Demand (Ey): It is the degree of change or responsiveness of quantity demanded of a good to a change in the income of the consumer. Ey =
% change in Qd = % change in Income
q/q y/y
TYPES OF ELASTICITY OF DEMAND 3. Cross Elasticity of Demand (Exy): It is the percentage change in the quantity demanded of one commodity say X due to the percentage change in the price of related commodity Y. Exy =
% change in Qd of X % change in Price of Y
=
qx/qx Py/Py
Cross Elasticity is concerned with two types of goods 1). Substitutes, it has positive Exy 2). Complementary, it has negative Exy
DEGREES OF PRICE ELASTICITY OF DEMAND Type of Elasticity
Curve Tendency
Elasticity Value
Perfectly Inelastic
Vertical
ε=0
Perfectly Elastic
Horizontal
ε=
DEGREES OF PRICE ELASTICITY OF DEMAND Type of Demand
Curve Tendency
Elasticity Values
Elasticity For
Elastic
Relatively Flat
E>1
Luxuries
Inelastic
Relatively Steep
E<1
Necessities
DEGREES OF PRICE ELASTICITY OF DEMAND • Unitary Elasticity = 1 D Price P1 10% Po 10% 0
Q1 Qo
D
Quantity
DETERMINANTS OF PRICE ELASTICITY OF DEMAND
Necessities vs. Luxuries
Availability of Substitutes
Proportion of Income
Time
MEASUREMENT OF PRICE ELASTICITY OF DEMAND 1. Total Outlay or Revenue Method:
We measure “Ed” with change in Total Revenue of a firm due to change in a it’s price level.
Elasticity is expressed in Three ways; Unitary Elasticity (Total Revenue remains the same) Elastic Demand (TR increases with decrease in the prices) Inelastic Demand (TR decreases with decrease in the prices)
MEASUREMENT OF PRICE ELASTICITY OF DEMAND Total Outlay or Revenue Method: Price of Pencil per Dozen (Rs.)
Quantity Demanded in Dozen
Total Revenue
8
3
24
7
4
28
Elastic
6
5
30
Elastic
5
6
30
Unity
4
7
28
Inelastic
3
8
24
Inelastic
Coefficient of Elasticity of Demand
MEASUREMENT OF PRICE ELASTICITY OF DEMAND 2. The Proportional or Percentage Method:
Under this method we calculate Ed by the formula as
Ed =
=
% change in Qd % change in Price Q2 – Q1 P2 – P1
X Q1
=
P1
q/q p/p
MEASUREMENT OF PRICE ELASTICITY OF DEMAND 3. Geometrical or Point Method
Under this method we measure elasticity of demand at any point on a demand curve.
Ed = Lower Amount of Qd from the midpoint Upper Amount of Qd from the midpoint At midpoint Above midpoint
Ed = 1 Ed < 1
APPLICATIONS OF ELASTICITY OF DEMAND
Taxation Monopolist Price Wages Economic Policies International Trade Rate of Foreign Exchange
ELASTICITY OF SUPPLY
The percentage increase in the amount of Quantity Supplied in response to a given percentage increase in price.
It represents the extend of change in supply in response to a change in price.
The rate at which quantity supplied varies with a change in the price of that commodity. Es =
% change in Qs % change in Price
=
q/q p/p
DEGREES OF ELASTICITY OF SUPPLY
Perfectly Elastic Supply (Horizontal & Infinite)
Perfectly Inelastic Supply (Vertical & Zero)
Elastic Supply
Inelastic Supply
ELASTICITY OF SUPPLY
The Short Run:
Es is more Inelastic or even Perfectly Inelastic because a firm cannot change its machinery in short run.
The Long Run:
Es is more elastic in this case because it can change all it factors of production to supply more goods.