ELASTICITY OF DEMAND
• INTRODUCED BY ALFRED MARSHALL• ELASTICITY OR RESPONSIVENESS OF
DEMAND IN A MARKET IS GREAT OR SMALL ACCORDING AS THE AMOUNT DEMANDED INCREASES MUCH OR LITTLE FOR A GIVEN FALL IN PRICE AND DIMINISHES MUCH OR LITTLE FOR A GIVEN RISE IN PRICE.
TYPES OF ELASTICITY OF DEMAND
• PRICE ELASTICITY OF DEMAND• INCOME ELASTICITY OF DEMAND• CROSS-ELASTICITY OF DEMAND
PRICE ELASTICITY OF DEMAND
• DEGREE OF RESPONSIVENESS OF QUANTITY DEMANDED TO A CHANGE IN PRICE IS CALLED PRICE ELASTICITY OF DEMAND. =
PERCENTAGE CHANGE IN QUANTITY DEMANDED
PERCENTAGE CHANGE IN PRICESYMBOLICALLY
eP =Q/QP/P
P
Q
CHANGE
PRICE
QUANTITY
MEASUREMENT OF PRICE ELASTICITY OF DEMAND
• PERCENTAGE METHOD• POINT METHOD OR SLOPE
METHOD• TOTAL OUTLAY METHOD• ARC METHOD
PERCENTAGE METHOD• RELATIVE CHANGE IN DEMAND DIVIDED BY
RELATIVE CHANGE IN PRICE OR PERCENTAGE CHANGE IN DEMAND DIVIDED BY PERCENTAGE CHANGE IN PRICE.
eP =Q
P
%
%
FOR EXAMPLE IF PRICE OF RICE INCREASES BY 10% AND DEMAND FOR RICE FALLS BY 10% eP = 15/10 = 0.5THIS MEANS THAT DEMAND FOR RICE IS INELASTIC
MEASURES OF ELASTICITY
• REALTIVELY ELASTIC IF e>1• REALTIVELY INELASTIC IF
e<1• UNITARY ELASTIC DEMAND
IF e=1• PERFECTLY INELASTIC
DEMAND IF e=0• PERFECTLY ELASTIC
DEMAND IF e=INFINITY
RELATIVELY ELASTIC
O Q Q1
P1
P
D
QUANTITY DEMANDED
PRIC
E
RELATIVELY INELASTIC
O Q Q1
P1
P
D
D
QUANTITY DEMANDED
PRIC
E
UNITARY ELASTIC DEMAND
O Q1Q
P1
P
D
QUANTITY DEMANDED
PRIC
E
PERFECTLY INELASTIC DEMAND
O Q
P1
P
D
QUANTITY DEMANDED
PRIC
E
PERFECTLY ELASTIC DEMAND
O Q Q1
P D
QUANTITY DEMANDED
PRIC
E
POINT METHOD
• WE CAN CALCULATE PRICE ELASTICITY OF DEMAND AT A POINT ON THE LINEAR DEMAND CURVE.
eP
LOWER SEGMENT OF DEMAND CURVE UPPER SEGMENT OF DEMAND CURVE
=
D
C
.
.
A
B
E
AE – UPPER SEGMENTEB – LOWER SEGMENT
O
POINT METHODPR
ICE
QUANTITY DEMANDED
For example in fig. the length of the demand curve AB is 4cm.
• Ep at point E ,ep = EB/EA = 2/2 = 1• Ep at point D = (middle point of EB portion of
demand curve) DB/DA = 1/3 = 0.3 ep<1• Ep at point c(middle point of EA portion of
demand curve) = CB/CA = 3/1 = 3 ep >1• Ep at point B = 0/AB = 0/4 = 0• Ep at point A = AB/0 = 4/0 = infinity
TOTAL OUTLAY METHODWe can measure elasticity through a change in expenditure on
commodities due to a change in price
• Demand is elastic if total outlay or expenditure increases for a fall in price(ep>1)
• Demand is inelastic if total outlay or expenditure falls for a fall in price(ep<1)
• Demand is unitary if total expenditure does not change for fall in price(ep=1)
TYPES OF ELASTICITY OF DEMANDCHANGES IN PRICE
Ep = 1 Ep<1 Ep>1
FALL IN PRICE
TOTAL OUTLAY REMAINS CONSTANT
TOTAL OUTLAY FALLS
TOTAL OUTLAY RISES
RISE IN PRICE
TOTAL OUTLAY REMAINS CONSTANT
TOTAL OUTLAY RISES
TOTAL OUTLAY FALLS
ARC METHOD
• SEGMENT OF DEMAND CURVE BETWEEN TWO POINTS IS CALLED AN ARC.
Ep = q1 – q2 / P1-P2 Q1+q2 P1+P2
= q Q1+q2 /
PP1+P2
Q = change in qty demandedP = change in price of the commodityP1 = original priceP2 = New priceQ1 = original qtyQ2 = new qty
ARC ELASTICITY
O Q1 Q2
P1
A
B
P
QQUANTITY DEMANDED
PRIC
E
P1
INCOME ELASTICITY OF DEMAND
• DEGREE OF RESPONSIVENESS OF DEMAND TO CHANGE IN INCOME.
Ey = Percentage change in qty demanded Percentage change in income
Ey = q/q x y/ yQ- quantity demandedY - income
Cross elasticity of demand
• Responsiveness of demand to change in price of realted goods.
Ec = Percentage change in qty demanded of commodity X Percentage change in price of commodity Y
Ec= qx/ py x py/qx
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