Topic

a) Elasticity Of Demand
 Meaning Of Elasticity
 The term Elasticity expresses the degree of correlation
between demand and Price.
 The elasticity of demand is a measure of the relative
change in account purchased in response to a relative
change in price on a given demand curve.
- Mayer A.L.
 The elasticity of demand, at any price or at any output,
is the proportional change of amount purchased in
response to a small change in price, divided by the
proportional change of price
Mrs. Joan Robinson
 Classification of Elasticity of
Demand

 From
the viewpoint of Elasticity
Demand May be two types: -

a. Elastic Demand
b. Inelastic Demand
Types of elasticity

•Price elasticity
•Cross elasticity
•Income elasticity
•Promotional elasticity
 Price Elasticity

Price Elasticity = Proportion Change in amount Demanded

Proportion Change in Price

Change in Demand / Change in Price

Amount Price
 Five Cases Of Elasticity
 There are five cases for measuring the
price elasticity of demand. they are:
(a) Elasticity greater than one[ed>1]
(b) Elasticity less than one[ed<1]
(c) Elasticity equals to one[ed=1]
(d) Perfect elasticity
(e) Imperfect or zero elasticity[ed=0]
Elasticity greater than one [Ed >
1]:
 Ifthe change in
demand is greater
than the change in
price, Then it is said
to be elasticity
greater than one
[ed>1]. It is also
called elasticity of
demand
 Elasticity less than one
[Ed < 1]:
 Ifthe change in
demand is less than
the change in price,
Then it is said to be
elasticity less than
one [ed<1]. It is
also called
inelasticity of
demand.
 Elasticity Equals to one
[Ed = 1]:

 Ifthe rate of change in

demand and the rate of
change in price are
equal, Then it is said to
be elasticity equals to
one [ed=1]. It is also
called unit elasticity
 Perfect Elasticity
 Ifa little change in
price of a particular
product causes a
severe effect on
the change in
demand of that
particular product,
then it is said to be
perfect Elasticity.
 Imperfect Elasticity

 Ifthe change in
price of a product
does not have any
impact on the
change in demand,
then it is said zero
(0) elasticity
 Elasticities Extreme

P Perfectly Inelastic
Demand (Insulin)

D
Perfectly Elastic
Demand (Clear Pepsi)

Q
Demand Curves

Elastic Unit Inelastic

 Determinants of price
elasticity
 Availabilityof substitutes
 Nature of commodity (luxuries or
necessities)
 Use of the commodity
 Proportion of market supplied
 Proportion of the income spent
 Time required in adjusments
 Elasticity and Revenues
 The revenues generated by a firm along any
point of the demand schedule are equal to
the product of quantity demanded and price

 R = P∙QD
Raising prices has two counter-veiling effects:
1. a direct positive impact on revenues because
each good sold generates more revenue.
2. a negative indirect impact because fewer goods
will be sold.
 Which is stronger?
 Effect of price change on
revenues

 Changes in revenues are approximately

%R ≈ %P+%Q
 Divide through by %P to get the total impact
D
% R % P %Q %Q
= + = 1+
%P %P %P %P

%R = 1 +e Demand
%P
e Demand
<0
 Price Elasticity & Revenues
 If the price elasticity of demand is
 exactly UNITY, a price rise has no effect
on total revenue
 ELASTIC, a price rise will decrease
revenues.
 INELASTIC elastic, a price rise will
increase revenues.
 Cross Elasticity of Demand
 The relationship between changes in the
price of one commodity and the resulting
changes in the quantity demand of
another commodity is described as the
cross elasticity of demand.
 It has three types: -
1. Positive cross Elasticity of Demand
2. Negative cross Elasticity of Demand
3. Zero cross Elasticity of Demand
 Substitutes vs.
Complements
 A good is defined as a “Substitute”
when a rise in its price leads to a
shift out/up in the demand curve
for the good of interest.

A good is defined as a
“Complement” when a rise in its
price leads to a shift in/down in the
demand curve for the good of
interest.
 Income Elasticity
 Income elasticity is a measure of
responsiveness of potential buyers to
change in income. It represents the ratio of
change in demand of product as with the
change in income of the consumer
concerned.

 It is of four types:
1. Positive Income Elasticity of Demand
2. Negative Income Elasticity of Demand
3. zero Income Elasticity of Demand
4. Other types of Income elasticity
Nature of goods and income
elasticity

 Withthe concern of elasticity of demand,

we can differentiate goods or products into
two distinct types. They are –
1. NORMAL GOODS
Necessities
luxuries
2. INFERIOR GOODS
 Luxuries vs. Necessities
 There are two types of normal goods.
 Luxuries take up an increasing share of
income as your income grows.
Luxuries are income elastic - the income
elasticity of luxuries is greater than 1.
Necessities take up a declining share of
income as your income grows.
Necessities are income inelastic – the
income elasticity of luxuries is less than 1.
 Inferior Goods

 Inferior Goods are goods that are so

inferior that the Law of Demand does not
apply.
 Example: Noodles in poorer parts of China.
Noodles are a big chunk of the household
budget. When prices of noodles go down,
that frees up extra money for other
spending. With extra money, you might
buy more meat. Then, you need fewer
noodles. Price of noodles drops and
demand for noodles drops!
Inferior Goods
Range of Income
Elasticities
Normal Goods

0 1

Income Inelastic Income Elastic

(Necessities) (Luxury Goods)
 Measurement of Elasticity
 Three methods have been suggested for
the measurement of elasticity:
1. Proportional Method.
2. Geometrical Method.
 Proportional Method
 In this method, we compare the
percentage change in price with the
percentage change in demand. The
elasticity is the ratio of the percentage
change in the quantity demand to the
percentage change in price change.
 Geometrical Method
 Arc Elasticity
 Any two points on a
demand curve make an
Arc. The area between P
and M on the DD curve in
this figure is an arc which
measures elasticity over
a certain range of prices
and quantities
 Drawback of arc
elasticity

Arc elasticity method differs

from two finite points if
direction changes.
 Point Elasticity:
This method tells us how
measure elasticity of
demand at any point on a
demand curve. Elasticity
is represented by the
fraction distance from D
to a point on the curve
divided by the distance
from the other end to that
point.
Promotional elasticity
It is defined as change in
demand of the quantities in
response to change in
expenditure

E=change in sales
Change in advertisement
expenditure
 Determinants of promotional
elasticity
 The level of total sales

 Advertisement of rival firms

 Cumulativeeffect of past
advertisements
Price Elasticity and Time
 Elasticity of Demand
Short-term vs. Long-term
 It takes time to find substitutes for goods
or to adjust consumption behavior in
response to a change in prices.
 The long-run demand response to a price rise
is larger than the short-run. Price elasticity of
demand is more negative in the long run than
in the short run.
.
Oil Demand much more elastic
in long run than short-run

Price E–(J.C.B. Cooper, OPEC Review, 2003)

 Oil Dempand Curves
P

Short-term Long-term
Q
Practical Application of Elasticity
of Demand
 Taxation
 Monopoly Market
 Appraisal
 Economic policies
 International Trade
 Rate of Foreign Exchange
 Increasing Returns
 Output
 Wages
 Poverty in plenty
 Effect on the economy
Thank You All