ELASTICITY OF DEMANDECONOMICS

Submitted by:ADITYA AMAR2014006SEMESTER IIDAMODARAM SANJIVAYYA NATIONAL LAW UNIVERSITYVisakhapatnamMarch 2015

1

CERTIFICATE

Title of the subject: elasticity of demandName of the faculty: Prof. AbhishekSinha

ParticularsDate and signature of the facultyRemarks

Abstract

First consultation

Second consultation

Third consultation and final submission

I, Aditya Amar, hereby declare that this Project titled elasticity of demand by me is an original work undertaken by me. I have duly acknowledged all the sources from which the ideas and extracts have been taken. The projects free from any plagiarism issue.

(Signature of the candidate)Place: Visakhapatnam Name: Aditya AmarDate: 1/03/2015 Roll No. 2014006 Semester II

TABLE OF CONTENTTITTLEPAGE NO.

CERTIFICATE2

ACKNOWLEDGMENT 4

ABSTRACT5

INTRODUCTION5

Meaning and definition of elasticity of demand Importance of concept of elasticity Factors influencing price elasticity of demand Degrees of elasticity Measurement of elasticity Reason for decline in demand Determinants of Demand66910141718

CONCLUSION21

BIBLIOGRAPHY22

ACKNOWLEDGEMENTI have endeavored to attempt this project. However, it would not have been feasible without the valuable support and guidance of Prof. AbhishekSinha. I would like to extend my sincere thanks to him.I am also highly indebted to Damodaram Sanjivayya National Law University Library Staff, for their patient co-operation as well as for providing necessary information & also for their support in completing this project.My thanks and appreciations also go to my classmates who gave their valuable insight and help in developing this project.

ELASTICITY OF DEMANDABSTRACTAim and ObjectiveThe aim of the project is to present a detailed study of the topic Elasticity of Demand (types and measurement)through, suggestions, different writings and articles. Research Plan Doctrinal method has been followed.Type of StudyDescriptive and analyticalScope and limitations Though the topic Elasticity of Demand (types and measurement) is an immense project and pages can be written over the topic but because of certain restrictions and limitations I was not able to deal with the topic in great detail.Source of DataThe following secondary sources of data have been used in the project: Articles/Journals/Law Reports Books Websites

INTRODUCTIONDemand is desire backed by willingness to pay and ability to pay i.e. a wish to have a commodity does not become demand. A person wishing to have a commodity should be willing to pay for it and should have ability to pay for it. Thus a desire becomes demand if it is backed by willingness to pay and ability to pay. Demand is meaningless unless it is stated with reference to a price.Decisions regarding what to produce, how to produce and for whom to produce are taken on the basis of price signals coming from the market. The law of demand explains inverse relationship between price and quantity demanded. When price falls quantity demanded of that commodity will increase. The deficiency of law of demand is removed by the concept of elasticity of demand.MEANING AND DEFINITION OF ELASTICITY OF DEMANDThe term elasticity was developed by Alfred Marshall, and is used to measure the relationship between price and quantity demanded. The law states that the price of a commodity falls, the quantity demanded of that commodity will increase, i.e. it explains only the direction of change in demand and not the extent of change. This deficiency is removed by the concept of elasticity of demand.Elasticity means responsiveness. Elasticity of demand refers to the responsiveness of quantity demanded of a commodity to change in its price.According to E.K. Estham, elasticity of demand is a measure of the responsiveness of quantity demanded to a change in price.IMPORTANCE OF THE CONCEPT ELASTICITYThe concept of elasticity of demand plays a crucial role in business-decisions regarding fixing of price with a view to make larger profit. For instance, cost of production is increasing the firm would want to pass the rising cost on to the consumer by raising the price. Firms may decide to change the price even without any change in the cost of production. But whether raising price following the rise in cost or otherwise proves beneficial depends on:a)The price elasticity of demand for the product, i.e. how high or low is the proportionate change in its demand in response to a certain percentage change in its price.b)Price elasticity of demand for its substitutes, because when the price of a product increases the demand for its substitutes increases automatically even if their prices remain unchanged.Raising the price will be beneficial only if:a) Demand for a product is less elasticb)Demand for its substitutes is much less elastic.Elasticity of demand establishes the quantitative relationship between quantity demanded and price or other demand determinants.TYPES OF ELASTICITY These are three types of elasticity:-1.Price elasticity2.Incomeelasticitya.Zeroincome elasticityb.Negative incomeelasticityc.Positive income elasticity3.Cross elasticity1. Price Elasticity-Price elasticity of demand may be defined as the degree of responsiveness of quantity demanded of a commodity in response to change in its price i.e. it measures how much a change in price of a good affects demand for that good, all other factors remaining constant. It is calculated by dividing the proportionate change in quantity demanded by the proportionate change in price.EP= Proportionate change in quantity demanded Proportionate change in price2. Income elasticity-Income elasticity of demand measures how much a change in income affects demand for that commodity if the price and other factors remain constant.A product with an income elasticity of more than one will experience a growth in demand that is higher than growth in consumers income. Luxury goods tend to have relatively high income elasticity. Low quality goods have negative income elasticity, as people stop buying them when they can afford to.Ed= Proportionate change in quantity demanded Proportionate change in income

There are three types of income elasticity Zero income elasticity Here a change in income will have no effect of quantity demanded. For example: - salt, matches, cigarettes.Negative income elasticity Here an increase in income leads to a decrease in quantity demanded. This happens in inferior goods.Positive income elasticity In this an increase in income will leads to an increase in quantity demanded. For most goods income elasticity is positive.3. Cross elasticityThis measures the change in demand for a commodity due to change in price of another commodity.ED= Percentage change in quantity demanded of commodity APercentage change in price of commodity BIf the goods having substitutes the cross elasticity is positive i.e. an increase in the price of X will result in an increase in sales of Y. If the goods are complementary and increase in the price of one commodity will depress the demand for the other. So cross elasticity will be negative. If the goods are unrelated cross elasticity will be zero. Because however much the price of one commodity increased demand for the other will not be affected by that increase.FACTORS INFLUENCING PRICE ELASTICITY OF DEMAND1. Nature of commodityElasticity depends on whether the commodity is a necessity, comfort or luxury. Necessities of life have inelastic demand and comforts and luxuries have elastic demand.2. Availability of substitutesGoods with substitutes have elastic demand and goods without substitutes have inelastic demand. For example: coffee and tea are substitutes. If price of tea increases, people may switch over to coffee. If price of coffee raises people may shift to tea. The demand of salt is inelastic.3. Uses of the commodityCertain goods can be put to many uses. Example electricity. Such goods have elastic demand because as the price decreases, they will be put to more uses.4. Proportion of income spent on commodityFor some goods, consumers spend only a small part of their income. The demand will be inelastic. For eg: - salt and matches5. Price of goodsGenerally cheap goods have inelastic demand and expensive goods have elastic demand.6. Income of consumersVery rich people have inelastic demand for goods and poor people have elastic demand. Because rich people will buy the commodity at all levels of prices where poor people there is a change in quantity of consumption according to change in price.7. Time periodElasticity would be more in the long run than in the short run. Because in the long run consumers can adjust their demand by switching over to cheaper substitutes. Production of cheaper substitutes is possible only in the long run.8. Distribution of income and wealth in the societyIf there is unequal distribution of income, the demand of commodities will be relatively inelastic. If the distribution of income and wealth in the society is equal there will be elastic demand for commodities.DEGREES OF ELASTICITYSince the responsiveness of quantity demanded varies from commodity to commodity and from market to market, it is important to study the degrees of price elasticity. We can identify five degrees of elasticity. They are: -1.Perfectly elastic demand2.Perfectly inelastic demand3.Unitary elastic demand4.Relatively elastic demand5.Relatively inelastic demand

1. Perfectly elastic demandPerfectly elastic demand is the situation where a small change in price causes a substantial change in quantity demanded i.e. a slight decline in price causes an infinite increase in quantity demanded and a slight increase in price leads to demand contracting to zero. The demand is hypersensitive and the elasticity of demand is infinite. Demand curve becomes a horizontal straight line parallel to x-axis

Priceep = 2DY

0XQty demanded2. Perfectly inelastic demand It is the situation wherechanges in price cause no change in quantity demanded. Quantity demanded is non-responsive or inelastic. Demand curve is a vertical line parallel to Y-axis and the elasticity of demand is zero.

P1

ep = 0Price

P

MP2Quantity demanded

It is clear that the price is OP or OP1 or OP2. The quantity demanded remains unchanged at OM.

3. Unitary elastic demandIt refers to that situation where a given proportionate change in price is accompanied by an equally proportionate change in quantity demanded. For example, if price changes by 10%, quantity demanded also changes by 10%.

ie; elasticity will be equal to one. The demand curve is a rectangular hyperbola.ep =1PriceP1P

Y

D

D

0

XN1NQuantity demanded4. Relatively elastic demandDemand is said to be relatively elastic when a given proportionate change in Price causes a more than proportionate change in quantity demanded

ep>1Y

DPPrice

D

P1

0XN1N

5. Relatively Inelastic demand

Demand is relatively inelastic when a given proportionate change in price causes a less than proportionate change in quantity demanded. Demand curve will be a very steep curve. Elasticity is less than 1. For example, If price changes by 20% quantity demanded changes by 10%Then ep = 10/20 = .5 ie; ep 154

e = 160

e 1If total expenditure decreases, elasticity1

PRICE

ep=1

ep