Elasticity of Demand

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.