Elasticity.ppt 1

7/29/2019 Elasticity.ppt 1

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ELASTICITY OF DEMAND

Demand varies with price. But the variation is not uniform

in all cases. Sometimes demand is greatly responsive to price and at

times nominal or not so responsive. Economists use the term Elasticity for this response. To measure the E of D , 2 variables are considered-

Demand and Determinants of demand.

For Measuring the E coefficient , thus a ratio is made ofthe two variables.

E of D= % change in qt. demanded / % change in

determinant of demand There are 3 elasticities of D

Price E Income E Cross Price E or just Cross Elasticity


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Price Elasticity of Demand

The price elasticity of demand (PED) is an

elasticity that measures the nature andpercentage of the relationship between changes

in quantity demanded of a good and changes in

its price, other determinants remaining constant.

The extent of response of demand for a

commodity to a given change in price, other

demand determinants remaining constant , is PE

of D. It is the ratio of the relative change indemand and price variables.
http://en.wikipedia.org/wiki/Elasticity_%28economics%29http://en.wikipedia.org/wiki/Pricehttp://en.wikipedia.org/wiki/Pricehttp://en.wikipedia.org/wiki/Elasticity_%28economics%29


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The co-efficient of price elasticity (e) is measured as:

E =

Since relative change of variables can be measured either in

terms of % change or proportional change, the PE co-efficient can

be measured alternatively as

E =

% change in Qt. demanded

% change in price

Proportional change in Qt. demanded

Proportional change in price

Q/Q P/P = Q/Q X P/P

or

Q/ P = P/Q

WhereQ= original demand (q1)

P= the original price(p1)

Q = the change in demand =

new D(Q2)-old demand(Q1)

Thus Q= Q2-Q1

P = P2-P1


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P = P2-P1 = 21-20 =1

P=P1=20Q= Q2- Q1 = 96-100= -4

Q=Q1=100

E = -4/100X20/1= 4/5= -0.8

EOD is less than 1.

(minus sign ignored)

P of Apples

(Rs)

Qt. Demanded

(kg)

20 (P1) 100(Q1)

21 (P2) 96(Q2)


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Deductions

Depending upon the magnitudes andproportional changes involved in data on demandand prices, one may obtain various numericalvalues of co-efficient of PE, ranging rom zero to

infinity. When PE Co-efficient is > than unity (e>1), it issaid to be price elastic.

If e


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Types of Price Elasticity

Marshal suggested a 3-fold classofocation of types

of PEDUnit EOD (e=1)

Elastic D (e>1)

Inelastic D (e


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Price Elasticity of Demand

NumericalValue

Terminology Description

E= infinity Perfectly (or infinitely) Elastic D Consumers have infinite demand at aparticular price and none at all at aneven slightly higher than this given

price.

E=0 Perfectly (or completely) Inelastic D D remains unchanged , whatever bethe change in price.

E>1 Relatively Elastic D Qt. demanded changes by a largepercentage as does price

E


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Perfectly E Demand (e=infinity)

An endless demand(infinite) demand at thegiven price is PED.

With Slight increase inprice of a commodity, thestops buying it.

But the decrease in pricethe demand curve will shiftdownwards. PED is atheoretical extremity,hardly encountered in

practice. D curve is straight

horizontal line

P increases D= 0P1

P2

P

D1D1

DD

Price

Qt Purchased/unit of time


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Perfectly Inelastic Demand (e=0)

When demand of acommodity shows noresponse at all to achange in Price, the

demand remainssame.

D Curve is straightvertical line.

Again a theoreticalconsideration but salthas PID as it is anabsolute necessity.

P1

P3

P2

DD

Price



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Relatively Elastic D or More Elastic Demand (e>1)

When the proportion of

change in the qt.demanded is greater thanthat of the price, thedemand is said to berelatively elastic.

The numerical value liesbetween 1 and infinity.Represented by graduallysloping rather flatter Dcurve.

Realistic and practicalconcept.

P1

P2DD

Price


M1 M2


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Relatively Inelastic D or Less Elastic Demand (e


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Unitary Elastic Demand (e=1)

When the proportionof change in demandis exactly the same asthe change in price,

the D is said to beunitary elastic.

Numerical value ofUE=1. D curve wouldbe rectangular

hyperbola.

P1

P2

DD

Price


M1 M2


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Factors Influencing EOD

Nature of Commodity: Luxury, comfort and necessity goods. Luxury and comfort

goods are price elastic.Ex: Radio, furniture, car, etc.

Necessity goods are price inelastic

Ex: Food grains, cloth, salt, etc.

Availability of substitutes: Commodities having close substitutes - D = elastic

Ex: Tea, coffee, coke No substitutes D = inelastic

Ex: salt, potatoes, onion.

Number of Uses: Single (less elastic) and multi-use goods (high elastic).

Ex: coal is used by railways (inelastic) and consumersas fuel (elastic)


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Consumers Income: Larger Income-demand for overall commodities- relatively inelastic. Millionaire rarely affected.

Redistribution of income in favour of low income people may tendto make demand for some goods relatively elastic.

Height of Price and Range of Price change: In luxury goods , for a small change in price, the demand is

inelastic. If large change in price then D is elastic.

Perishable goods: change in P D is inelastic (potatoes, onions) Proportion of expenditure: Cheap or small expenditure items tend to have more demand

inelasticity than expensive or large expenditure items

Durability of Commodity: Durable goods: D inelastic in short run. Perishable goods: D- elastic. Ex: Milk, Vegetables


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Habit:E< 1.

Ex: Cigarettes- inelastic demand

Complementary goods: Goods jointly demanded have less elasticity (Inelasticity ):

Ex: Ink, Pen.

Time :

In SR D is less elastic. In LR D is more elastic. D for certain goods can be postponed in SR but has to be satisfied in LR.

Recurrence of Demand: D of a commodity is of recuring nature, its PE is higher.

Ex: Pizza, Buger, etc.

But less for goods purchased only once.Ex: Bicycles, Tape recorders.

Possibility of postponement: If the purchase is postponed, D will be elastic.

Ex: Cement, Bricks, etc

In consumption goods- Inelastic

P ti l A li ti f PED


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Practical Applications of PED

Production Planning Helps in fixing the prices of different goods

Helps in fixing the rewards of factor inputs

Helps in determining the foreign exchangerates

Helps in determining the terms of trade

Helps in fixing the rate of taxes

Helps in Declaration of Public Utilities


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Income Elasticity

Income is a major determinant of D for a number

of goods.

D= f(m)

IED measures the degree of responsiveness ofdemand for a good to changes in the

consumers income.

DEF: The IE is defined as a ratio percentage orproportional change in the quantity demanded to

the % or proportional change in income.


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IE= coefficient is thus measured as

IE = % change in Qt. demanded

% change in income

Em= % Q/ M = Q/Q X M/ M

or

Q/ M = M/Q

Where

Q= original demand (q1)

M= Initial Income (M1)

Thus Q= Q2-Q1

M = M2-M1


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Types of IE

Unitary ED (Em=1)

IE of D > unity (Em>1)

IE of D =0 and


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Determinants of IED

Nature of the Product

Level of Income in a country Time Period

P ti l A li ti f IE


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Practical Applications of IE

Rate of Growth of the firm

Housing Development Strategies

Ensuring Stability in Production

Long term Business Planning

Production Planning and

Market Strategy

C El ti it f D d


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Cross Elasticity of Demand

Def: The cross elasticity of demand reers to the degree of responsiveness ofdemand for a commodity to a given change in the price of some relatedcommodity.

The cross elasticity of D between any 2 goods X and Y is measures by dividingthe proportionate change in the quantity demanded of X by the proportionatechange in the price of Y.

+ve CED between 2 goods = substitutes. -ve CED between 2 goods= complementary

CED= Prop or % change in D for X

Prop or % change in Price of Y

Ec or Exy=

Qx /Qx Py/Py=

Qx/ Py X Py/Qx

Where

Qx = change in qt. D for commodity X

Qx= Initial D for X

Py, Initial Price of Y

Py=change in price of Y


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Substitutes

Unrelated

Complementary

D for comm X

Ex

y>0

D for comm X

D for comm X

Exy

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Elasticity.ppt 1

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