2. The Law of Demand tells us that as the price of a
commodity falls, the quantity demanded
increases, and vice versa.
But, it does not state by how much the quantity
demanded increases as a result of a certain fall in
the price or by how much the quantity
demanded decreases as a result of a rise in price.
In other words, the law of demand tells us only
the direction of change, but not the rate at
which the change takes place.
3. Price Elasticity of Demand (or Elasticity of
Demand, as it is customarily known) tells us
the extent of such change.
Elasticity of demand can be defined as “the
degree of responsiveness of quantity
demanded to a change in price”
4. The price elasticity of demand may be measured by the following formula:
Proportionate change in the quantity demanded
ep = _______________________________________ OR
Proportionate change in price
Change in quantity demanded
________________________
Quantity demanded
= _______________________________________
Change in price
_____________
Price
5. (Q2 - Q1)
_________
Q1
ep = _____________________
(P2 - P1)
________
P1
where Q1 stands for quantity demanded before price change
Q2 stands for quantity demanded after price change
P1 stands for price charged before price change
P2 stands for price charged after price change
6. Illustration
Quantity demanded before price change (Q1) = 4,000
Quantity demanded after price change (Q2) = 5,000
Price charged before price change (P1) = 20
Price charged after price change (P2) = 18
Find the price elasticity of demand.
7. (5,000 – 4,000)
____________
4,000
ep = ___________________ = - 2.5
(18 – 20)
________
20
The price elasticity is negative emphasizing the inverse relationship
between price and demand.
However, the minus sign is omitted from the final result as the inverse
relationship is implied.
8. When the change in price is more, the following method of calculation of
elasticity of demand would be more appropriate:
Q2 – Q1
__________
Q2+Q1 Q2 – Q1
_____ _______
2 Q2 + Q1
ep = __________________ = _____________
P2 – P1 P2 – P1
___________ ______
P2+P1 P2 + P1
_____
2
9. Applying the above formula, the result of the problem given above
will be as under:
1,000
_____
9,000 1/9
ep = __________ = ______ = - 2.11
-2 - 1/19
___
38
A one per cent reduction in price will result in a 2.5% increase in
the quantity demanded according to the first formula and 2.1%
increase according to the second formula.
10. Perfectly elastic demand
In this case, no reduction in price is needed to cause an increase in
demand.
The firm can sell the quantity it wants at the prevailing price but
none at all at even a slightly higher price.
Perfectly inelastic demand
In this case, a change in price, howsoever large, causes no change
in quantity demanded.
11. Demand with unity elasticity
In this case, a given proportionate change in price causes an equal
proportionate change in the quantity demanded.
Relatively elastic demand
In this case, a reduction in price leads to more than proportionate change
in demand.
Relatively inelastic demand
In this case, a decline in price leads to less than proportionate increase in
demand.
12.
13. The demand for necessities is generally
inelastic because the consumption of a
necessary article does not change much with
a change in price. Example: Salt.
The demand for luxuries changes much due
to a price change and is therefore elastic.
Example: silk saree.
14. A commodity having a variety of uses has a
comparatively elastic demand. Example – Steel.
Steel can be used for many purposes.
A slight fall in steel price will bring forth demand
from many quarters and hence demand is
elastic.
A commodity having a limited use will have a
comparatively inelastic demand.
15. A commodity having a number of substitutes
has relatively elastic demand because if its
price rises, its consumption can be curtailed
in favor of the substitutes.
For example, if city bus fare rises, people will
use electric train.
16. People with high incomes are less affected by
price changes than people with low incomes.
A rich man will not curtail consumption of
fruits and or milk even if their price rises
significantly. But, poor man will curtail the
extent of consumption.
Hence, demand for fruits and milk is inelastic
for the rich but elastic for the poor.
17. Where an individual spends only a small part
of his income on the commodity, the price
change does not materially affect his demand
for the commodity. e.g. salt, match box, etc.
and the demand is inelastic .
18. The urgency of demand tends to cause
inelastic demand. e.g. cigarette, liquor, etc.
19. The more durable and repairable a
commodity, the higher is its elasticity of
demand. e.g. shoes.
20. If the frequency of purchase of a product is
very high, its demand is likely to be more
price elastic than in the case of a product
which is purchased less often.
21. Cross elasticity of demand may be defined as
‘the proportionate change in the quantity
demanded of a particular commodity in
response to a change in the price of another
related commodity’.
The effect of a change in the prices of related
goods upon the demand for a particular
commodity may be determined by measuring
the ‘cross elasticity of demand’.
22. Let u suppose, the price of one commodity, say Z is the
independent variable whereas the quantity of another commodity,
say X, is the dependent variable. The cross elasticity of demand
can be measured by the following formula:
Proportionate change in the quantity purchased of X
ec = __________________________________________
Proportionate change in the price charged for Z
If cross elasticity is positive, the goods are said to be substitutes; if
negative, the goods are complements.
23. Income elasticity of demand may be defined
as the degree of responsiveness of quantities
demanded to a given change in income.
Income elasticity of demand can be
measured by the following formula:
24. Proportionate change in quantities demanded
ey = ______________________________________ or
Proportionate change in income
Q2 – Q1
_______
Q1
= ______________________
Y2 – Y1
______
Y1
where Q1 stands for quantities demanded before the change in income
Q2 stands for quantities demanded after the change in income
Y1 stands for the income before change
Y2 stands for the income after change
25. Illustration:
Suppose a consumer, when his income is
Rs.10,000, purchases 10 Kgs of sugar. If his
income goes up to Rs.11,000, he is prepared
to purchase 12 Kgs. of sugar.
Find out the income elasticity of demand.
26. Q2 – Q1 12 - 10
_______ ______
Q1 10
ey = ________________ = ______________
Y2 –Y1 11,000 – 10,000
______ _____________
Y1 10,000
2/10
= ___________ =2
1,000/10,000
The demand for sugar is quite elastic.
27. Zero income elasticity
A change in income will have no effect on the quantity
demanded. e.g. Salt.
Negative income elasticity
An increase in income may lead to a reduction in the
quantities demanded. Such goods are called inferior
goods.
e.g. An increase in income might lead to shift is demand
from beedis to cigarettes.
28. Positive income elasticity
An increase in income may lead to an
increase in the quantity demanded. Such
goods are called superior goods.
Positive income elasticity can be of three
types
29. Unity elasticity
The elasticity is unity when an increase in income leads to a
proportionate change in the quantity demanded.
More than unity elasticity
The elasticity is more than unity when an increase in income leads to a
more than proportionate change in quantity demanded. Articles of
luxury fall in this category.
Less than unity elasticity
Elasticity is less than unity when the increase in income leads to a less
than proportionate change in the quantity demanded. Articles of
necessities characterize this category. e.g. Wheat and rice.
30. The expansion of demand by means of
advertisement and other promotional efforts
may be measured by advertising elasticity of
demand (also called promotional elasticity).
The promotional elasticity measures the
responsiveness of demand to changes in
advertising or other promotional expenses.
31. The formula for measurement of Advertising
elasticity of demand is given below:
Proportionate change in sales
ea = ______________________________
Proportionate change in
advertisement expenditure
32. Type of commodity
Advertising elasticity will tend to be higher for
luxuries than for necessities; also higher for new
products than for old ones.
Market share
The larger the firm’s market share, the lower the
advertising elasticity of demand and vice versa.
33. Rivals’ reactions
If rivals react by increasing their promotional
spending, the expenditure will tend to cancel each
other out, reducing advertising elasticity of demand.
State of economy
If economic conditions are good and households have
a high degree of discretionary income, they are more
likely to respond to advertising.
