Elasticityof demand

924 views
759 views

Published on

Micro Economics

Published in: Business
0 Comments
1 Like
Statistics
Notes
  • Be the first to comment

No Downloads
Views
Total views
924
On SlideShare
0
From Embeds
0
Number of Embeds
6
Actions
Shares
0
Downloads
47
Comments
0
Likes
1
Embeds 0
No embeds

No notes for slide

Elasticityof demand

  1. 1. Introduction The law of demand states that when the price of a commodity falls, the quantity demanded of that commodity will increase, i.e. it explains only the direction of change in demand and not the extent of change. This deficiency is removed by the concept of elasticity of demand.
  2. 2. Meaning of Elasticity The term elasticity was developed by Alfred Marshall, and is used to measure the relationship between price and quantity demanded. Elasticity means responsiveness. Elasticity of demand refers to the responsiveness of quantity demanded of a commodity to change in its determinant.
  3. 3. Kinds of Elasticities of Demand In view of its major determinants, economists usually consider three important kinds of elasticities of demand : i) Price elasticity ii)Income elasticity of demand iii)Cross price elasticity/ Cross elasticity
  4. 4. Importance of the concept ‘ELASTICITY’ This concept plays a crucial role in business-decisions regarding fixing of price with a view to make larger profit. For instance, when the cost of production increases, the firm would want to pass the rising cost on to the consumer by raising the price OR Firms may decide to change the price even without any change in the cost of production.
  5. 5. Contd… This would be beneficial depending on: a) The price elasticity of demand for the product. b) Price elasticity of demand for its substitutes, because when the price of a product increases the demand for its substitutes increases automatically even if their prices remain unchanged. Raising the price will be beneficial only if: a) Demand for a product is less elastic. b)Demand for its substitutes is much less elastic
  6. 6. Price Elasticity Of Demand Definition The change in the quantity demanded of a product due to a change in its price is known as Price elasticity of demand. In other words it is a proportional change in the quantity demanded to a proportional change in price. EP= Proportionate change in quantity demanded Proportionate change in price
  7. 7. Degrees Of Price Elasticity Of Demand 1) Perfectly elastic demand 2) Relatively elastic demand 3) Elasticity of demand equal to unity 4) Relatively inelastic demand 5) Perfectly inelastic demand
  8. 8. Perfectly elastic demand y Perfectly elastic demand curve P R I D C E 0 D When the demand for a product changes –increases or decreases even when there is no change in price, it is known as perfect elastic x demand.
  9. 9. y P Relatively elastic demand curve R D I C E D 0 demand x When the proportionate change in demand is more than the proportionate changes in price, it is known as relatively elastic demand.
  10. 10. y D P R Elasticity of demand equal to unity curve I C E D 0 demand x When the proportionate change in demand is equal to proportionate changes in price, it is known as unitary elastic demand
  11. 11. Y D Relatively inelastic demand curve P R I C E D O demand X When the proportionate change in demand is less than the proportionate changes in price, it is known as relatively inelastic demand
  12. 12. Y D P R I C When a change in price, howsover Perfectly inelastic large, change no demand curve changes in quality demand, it is known as perfectly inelastic demand E 0 D demand X
  13. 13. Y P R D I C E D3 D4 0 D5 DEMAND WHERE D1) Perfectly elastic demand D1 D2)Relatively elastic demand D2 D3)Elasticity of demand equal to unity D4)Relatively inelastic demand X D5)Perfectly inelastic demand
  14. 14. Measurement Of Price Elasticity Of Demand Important methods to measure the elasticity of demand are: Proportional or percentage method Expenditure or Outlay method Geometric or point method Arc Elasticity of demand
  15. 15. Percentage method or proportionate method
  16. 16. Example: At Rs. 46 per unit , the demand for a commodity is 30 units. If the price increases from Rs. 46 to Rs. 50 per unit, the demand decreases from 30 units to 15 units. The price elasticity of demand is:
  17. 17. Total Expenditure or Total Outlay Method Total expenditure on the commodity is measured as the product of price and quantity (Total expenditure = P × Q) when price changes, total expenditure (TE) on the commodity may increase, decrease or remain constant. Note the following situations: (i) If, TE remains constant even after change in , price elasticity of demand is said to be equal to unity (ii) If TE increases following a fall in P, and TE decreases following a rise in P (so that P and TE move in the opposite direction), price elasticity of demand is said to be greater than unity . Ed>1 (iii) If TE increases following an increase in P and TE decreases following a decrease in P (so that and TE move in the same direction), price elasticity of demand is said to be less than unity. Ed<1 .
  18. 18. Price Elasticity of Demand (Ed) P TE Ed = 1 Rises or falls No change Ed >1 Rises Decreases Falls Increases Rises Increases Falls Decreases Ed < 1
  19. 19. Example: When price of a good falls from Rs. 8 per unit to Rs. 7 per unit, its demand rises from 12 units to 16 units. The elasticity of demand is measured as under. Price (Rs) Demand (in units) Total Expenditure (Rs.) 8 12 96 7 16 112 Since, total expenditure increases with fall in price, elasticity of demand is greater than unity. It is a situation of elastic demand.
  20. 20. Example Quantity Total Expenditure Demanded (Q) (P x Q) 18 3 54 15 4 60 12 5 60 9 6 54 Price (P e>1 e=1 e <1
  21. 21. The Arc Elasticity of demand The arc elasticity of demand refers to the relationship between changes in price and the subsequent change in quantity demanded. Qo is the initial quantity demanded. Q1 is the new quantity demanded. Po is the initial price. P1 is the new price.
  22. 22. Factors Affecting Price Elasticity Of Demand Nature of the Commodity Availability of Substitutes Variety of uses of commodity Postponement Influence of habits Proportion of Income spent on a commodity Height of price and range of prices
  23. 23. Factors Affecting Price Elasticity Of Demand Income Groups Elements of time Pattern of income distribution Recurrence of demand Time Complimentary goods Durability of the commodity
  24. 24. Practical Importance of the Concept of Price Elasticity Of Demand The concept is helpful in taking Business Decisions Importance of the concept in formatting Tax Policy of the government For determining the rewards of the Factors of Production To determine the Terms of Trades Between the Two Countries
  25. 25. Practical Importance of the Concept of Price Elasticity Of Demand Determination of Rates of Foreign Exchange In economic Analysis ,the concept of price elasticity of demand helps in explaining the irony of poverty in the midst of plenty.
  26. 26. Types Of Income Elasticity Of Demand Positive Income elasticity of demand Negative Income elasticity of demand Zero Income elasticity of demand
  27. 27. Y D Income P A O D B S Quantity Demanded X
  28. 28. Positive Income elasticity of demand Income Elasticity Equal to Unity or One Income Elasticity Greater Than Unity Or One Income Elasticity Less Than Unity or One
  29. 29. Price P A Total Revenue B S Quantity Demanded (000s)
  30. 30. D Income Y O D Quantity Demanded X
  31. 31. Y F E Income C D B A O Quantity Demanded X
  32. 32. Proportionate change in Demand Income Elasticity Of Demand = Proportionate change in Income i.e. ∆q Income Elasticity Of Demand = Q X y ∆Y
  33. 33. Measurement Of Income Elasticity Of Demand Here , ∆q = Change in the quantity demanded. Q = Original quantity demanded. ∆y = Change in income. Y = Original income. For e.g. ,when Income of the consumer = 2,500/- , he purchases 20 units of X, when income = 3,000/- he purchases 25 units of X
  34. 34. Measurement Of Income Elasticity Of Demand Thus Income Elasticity of Demand ∆q ∆y X = Y Q = (5/20) X (2500/500) = 1.25 therefore here the IED is 1.25 which is more than one.
  35. 35. Factors Affecting Income Of Demand Income Itself Only. Price Of the Commodity
  36. 36. Importance Of the Concept of Income Elasticity Of Demand In production planning and management In forecasting demand when change in consumers income is expected In classifying goods as normal and inferior In expansion and contraction of the firm by the figure of income elasticity of demand Markets situations could be studied with
  37. 37. Cross Elasticity of Demand Cross elasticity of demand expresses a relationship between the change in the demand for a given product in response to a change in the price of some other product E.g. if the X tea demand reduces tremendously then its effect could be seen in demand of sugar and milk.
  38. 38. Types of Cross Elasticity of Demand Cross Elasticity of Demand Equal to Unity or One Cross Elasticity of Demand Greater than Unity or one Cross Elasticity of demand less than unity or one
  39. 39. Cross Elasticity of Demand = i.e. Proportionate change in Demand for product X Proportionate change in Price of product Y Cross Elasticity of Demand = ∆qx Qx / ∆p y Py
  40. 40. Y Price of Y D D O Demand for X X
  41. 41. D Price of Y Y D O Demand for X X
  42. 42. Y Price of Y D O Demand for X X
  43. 43. Importance of Cross Elasticity Of Demand The concept is of very great importance in changing the price of the products having substitutes and complementary goods . In demand forecasting Helps in measuring interdependence of price of commodity . Multiproduct firms use these concept to measure the effect of change in price of one product on the demand of their other product
  44. 44. Advertising Elasticity of Demand Advertising elasticity of demand is the measure of the rate of change in demand due to change in advertising expenditure The amount of change in demand of goods due to advertisement is known as Advertisement Elasticity of Demand .
  45. 45. Advertising Elasticity of Demand = i.e. Proportionate change in Demand for product Proportionate change in Advertising expenditure ∆qx Advertising Elasticity of Demand = Q ÷ ∆a A
  46. 46. Y Sales S S O Advertising Expenditure X
  47. 47. Factors Affecting Advertising Elasticity Of Demand The stage of the Product’s Market Development . Reaction of market Rival Firms. Cumulative Effect of Past Advertisement. Influence of Other Factors.
  48. 48. Importance of the Advertising Elasticity Of Demand in Business Decisions It is useful in competitive industries. Though advertisement shifts the demand curve to right path but it also increases the fixed cost of the firm.
  49. 49. Limitation of Advertising Elasticity of the Demand The impact of advertising on sales is different under different conditions, even if other demand determinants are constant. Like wise, it is difficult to establish any corelationship between advertising expenditure and volume of sales when there counter advertisements by rival firm in the market . The effect on sales depend on what the rivals are doing.
  50. 50. Elasticity of Supply Elasticity of Supply: a measure of the way suppliers respond to a change in price Elastic: sensitive/responsive to change in price (greater than 1) Inelastic: not sensitive or not responsive to a change in price (less than 1) Unitary: Equal change in price to equal change in supply (= to 1)
  51. 51. Elasticity of Supply  A supplier’s responsiveness to a price change is Elasticity of Supply called _________________  (think like a supplier/seller)  3 Factors that will determine a product’s elasticity 1. Availability of resources required to make the product 2. Amount of time required to make the product 3. Skill level of the worker needed to make the product
  52. 52. Elastic Supply  A product has elastic supply when a price 1. 2. 3. change causes a significant change in the quantity supplied. (What would have to be true (of a product) to allow a seller to quickly increase production if the market price goes up?) Abundance of resources required to make the product Product can be made quickly Low skill level of workers required
  53. 53. Slope of an Elastic supply curve  Remember, if the price changes, the quantity supplied changes a lot. This creates a flatter curve. P P2 s P1 Q1 Q2 Q
  54. 54. Inelastic Supply A price change causes very little change in the quantity supplied= Inelastic. This happens because… 1.The product requires scarce resources 2. It takes a long time to make 3. It requires a high skill level of workers examples? Hand crafted furniture diamonds
  55. 55. Slope of an inelastic supply curve If the market price goes up but the supplier cannot increase production very much, then this creates a steeper curve. s P P2 P1 Q1 Q2 Q

×