This presentation tells about Elasticity of demand, it's types and different methods for determining elasticity of demand

1. Elasticity of Demand
By
Venkateswarlu A

2. Overview of presentation
Individual demand and market demand
Elasticity of demand
Types of elasticity of demand
 Price elasticity of demand
 Income elasticity of demand
 Cross-Price elasticity of demand
Methods to determine elasticity
Using elasticities in managerial decision making
Gp No - 2 24 November 2015

3. The demand for a commodity arises from the
consumers’ willingness and ability to purchase
the commodity
Demand
0
1
2
3
4
5
6
7
1 2 3 4 5 6
Price(Px)
Quantity Demanded (Qdx)
Individual Demand
dx
0
1
2
3
4
5
6
7
100 200 300 400 500 600
Dx
Price(Px)
Quantity Demanded (Qdx)
Market Demand
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4. Elasticity of demand
It measures the responsiveness of consumer
for a commodity to the changes in its
determinants or forces.
Types of elasticity of demand:-
Price elasticity of demand
Income elasticity of demand
Cross-Price elasticity of demand
Gp No - 2 44 November 2015

5. Price elasticity of demand
It measures the responsiveness (elasticity) in
the quantity demanded of the commodity to a
change in it’s price.
EP =
∆𝑸
∆𝑷
×
𝑷
𝑸
Gp No - 2 54 November 2015

6. Types of Price elasticity of demand
Perfectly inelastic demand
Relatively inelastic demand
Unit elastic demand
Relatively elastic demand
Perfectly elastic demand
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7. Perfectly inelastic demand
Dx
Price(Px)
Quantity Demanded (Qdx)
X
Y
O
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8. Relatively inelastic demand
Price(Px)
Quantity Demanded (Qdx)
X
Y
p
p1
xx1O
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9. Unitary elastic demand
Price(Px)
Quantity Demanded (Qdx)
X
Y
p
p1
xx1O
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10. Relatively elastic demand
p
p1
xx1
Price(Px)
Quantity Demanded (Qdx)
X
Y
O
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11. Perfectly elastic demand
Price(Px)
Quantity Demanded (Qdx)
X
Y
p
x x1O
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12. Price elasticity at various points
EP =
∆𝑸
∆𝑷
×
𝑷
𝑸
B point=
−𝟏𝟎𝟎
𝟏
×
𝟓
𝟏𝟎𝟎
= -5
If
|EP| > 1 then the demand curve is elastic
|EP| = 1 then the demand curve is unitary elastic
|EP|< 1 then the demand curve is inelastic
1
2
3
4
5
6
Price(Px) Quantity Demanded (Qdx)
X
Y
O
A
B
C
F
G
H
J
100 200 400 500 600300
Gp No - 2 124 November 2015

13. Price elasticity at various points
A point= - 1(
𝟔
𝟎
) = ∞
B point= -1 (
𝟓
𝟏
) = -5
C point= -1 (
𝟒
𝟐
) = -2
F point= -1 (
𝟑
𝟑
) = -1
G point= -1 (
𝟐
𝟒
) = -1/2
H point= -1 (
𝟏
𝟓
) = -1/5
J point= -1 (
𝟎
𝟔
) = 0
1
2
3
4
5
6
Price(Px)
Quantity Demanded (Qdx)
X
Y
O
A
B
C
F
G
H
J
100 200 400 500 600300
Gp No - 2 134 November 2015

14. Point price elasticity
The responsiveness in the quantity demanded of
a commodity could be measured by the inverse of
the slope (∆𝑸/∆𝑷) is expressed in terms of the
units of measurement.
Note that the value of ∆𝑸/∆𝑷 is given by a1, the
estimated coefficient of P in regression equation.
EP = a1 ×
𝐏
𝐐
Gp No - 2 144 November 2015

15. Point price elasticity determination
Qd = 19306 – 1606P
Find the point price elasticity of demand if price is
Rs.7
Solution:
Qd =19306-1606(7) =8064
EP = a1 ×
𝐏
𝐐
EP = -1606×
𝟕
𝟖𝟎𝟔𝟒
EP= -1.39
Gp No - 2 154 November 2015

16. Arc price elasticity
We use this method more frequently than point
method to measure elasticity of demand between
two points on the demand curve.
EP =
𝐐𝟐−𝐐𝟏
𝐏𝟐−𝐏𝟏
x
𝐏𝟐+𝐏𝟏
𝐐𝟐+𝐐𝟏
Gp No - 2 164 November 2015

17. Arc price elasticity determination
Find the Arc price elasticity of demand between
C and F points.
Solution:
EP =
𝐐𝟐−𝐐𝟏
𝐏𝟐−𝐏𝟏
x
𝐏𝟐+𝐏𝟏
𝐐𝟐+𝐐𝟏
EP =
𝟑𝟎𝟎−𝟐𝟎𝟎
𝟑−𝟒
x
𝟑+𝟒
𝟑𝟎𝟎+𝟐𝟎𝟎
EP =
𝟕
−𝟓
EP = -1.4
Gp No - 2 174 November 2015

18. Income elasticity of demand
It measures the responsiveness (elasticity) in
the quantity demanded of the commodity to a
change in consumers’ income.
EP =
∆𝑸
∆𝑰
×
𝑰
𝑸
Gp No - 2 184 November 2015

19. Types of income elasticity of demand
Perfectly income inelastic demand
Relatively income inelastic demand
Unitary income elastic demand
Relatively income elastic demand
Perfectly income elastic demand
Gp No - 2 194 November 2015

20. Perfectly income inelastic demand
Dx
Income(I)
Quantity Demanded (Qdx)
X
Y
O
Gp No - 2 204 November 2015

21. Relatively income inelastic demand
Income
Quantity Demanded (Qdx)
X
Y
y
y1
x x1O
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22. Unitary income elastic demand
Income
Quantity Demanded (Qdx)
X
Y
y
y1
x x1O
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23. Relatively income elastic demand
y
y1
x x1
Income
Quantity Demanded (Qdx)
X
Y
O
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24. Negative income elastic demand
Income
Quantity Demanded (Qdx)
X
Y
y
xx1O
y1
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25. Point income elasticity
Note that the value of ∆𝑸/∆𝑰 is given by ai, the
estimated coefficient of I in regression equation.
EI = ai ×
𝑰
𝐐
Gp No - 2 254 November 2015

26. Point income elasticity determination
Find the point income elasticity of demand if
I=1.76, Qd =10312 and coefficient of I in
regression equation is 947.
Solution:
EI = ai ×
𝑰
𝐐
EI = 947 ×
𝟏.𝟕𝟔
𝟏𝟎𝟑𝟏𝟐
EI= 0.16
Gp No - 2 264 November 2015

27. Arc income elasticity
This uses the average of the original and new
incomes, and the average of the original and new
quantities.
EI =
𝐐𝟐−𝐐𝟏
𝐈𝟐−𝐈𝟏
x
𝐈𝟐+𝐈𝟏
𝐐𝟐+𝐐𝟏
Gp No - 2 274 November 2015

28. Arc price elasticity determination
Demand function for automobile industry is
Qd=40000+5(I). If income of a consumer raises
from 8000 to 9000 and sales from 70000 to 80000
then what is the Arc price elasticity of demand.
Solution:
EI =
𝐐𝟐−𝐐𝟏
𝐈𝟐−𝐈𝟏
x
𝐈𝟐+𝐈𝟏
𝐈𝟐+𝐈𝟏
EI =
𝟖𝟎𝟎𝟎𝟎−𝟕𝟎𝟎𝟎𝟎
𝟗𝟎𝟎𝟎−𝟖𝟎𝟎𝟎
x
𝟗𝟎𝟎𝟎+𝟖𝟎𝟎𝟎
𝟖𝟎𝟎𝟎𝟎+𝟕𝟎𝟎𝟎𝟎
EI = 10 x 0.1133
EI = 1.133
Gp No - 2 284 November 2015

29. Cross-Price elasticity of demand
It measures the responsiveness in the demand for
commodity X to change in the price of commodity Y.
This is given by the percentage change in the demand
for commodity X divided by the percentage in the price
of commodity Y, holding constant all the other variables
in the demand function.
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Exy =
∆Qx
∆P 𝒚
×
Py
Qx

30. Point cross-price elasticity
Note that the value of ∆𝑸𝒙/∆𝑷𝒚 is given by aS,
the estimated coefficient of Py.
Exy = as ×
Py
Qx
Gp No - 2 304 November 2015

31. Arc cross-price elasticity
Point cross-price elasticity of demand gives
different results, depending on whether the price
of the related commodity(Py) rises or falls. To
avoid this, we usually measure the Exy with
following formula
EP =
𝐐𝐱𝟐−𝐐𝐱𝟏
𝐏𝐲𝟐−𝐏𝐲𝟏
x
𝐏𝐲𝟐+𝐏𝐲𝟏
𝐐𝐱𝟐+𝐐𝐱𝟏
Gp No - 2 314 November 2015

32. Arc cross-price elasticity determination
Calculate the Exy if Py increases from Rs 50 to 100
and Qx increases from 125 to 150 units by using Arc
price elasticity of demand.
Solution:
Exy =
𝐐𝐱𝟐−𝐐𝐱𝟏
𝐏𝐲𝟐−𝐏𝐲𝟏
x
𝐏𝐲𝟐+𝐏𝐲𝟏
𝐐𝐱𝟐+𝐐𝐱𝟏
EXY =
𝟏𝟓𝟎−𝟏𝟐𝟓
𝟏𝟎𝟎−𝟓𝟎
x
𝟏𝟎𝟎+𝟓𝟎
𝟏𝟓𝟎+𝟏𝟐𝟓
EXY = 0.5 x 0.5454
EXY = 0.27
Gp No - 2 324 November 2015

33. Features of Cross-Price elasticity
If the value of EXY is positive, commodities X
and Y are substitutes
If the value of EXY is negative , commodities X
and Y are complementary
If the value of EXY is close to zero, X and Y are
independent commodities
Gp No - 2 334 November 2015

34. Using elasticities in decision making
The firm can estimate the elasticity of demand
with respect to all the forces or variables that
affect the demand for the commodity that the firm
sells. The firm needs these elasticity estimates in
order to determine the optimal operational policies
and the most effective way to respond to the
policies of competing firms.
Gp No - 2 344 November 2015