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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