7b3c6ab4-3931-4abd-8d26-e32a1fa26901.pptx

Law of
Demand
Law of Demand states that if price of commodity
increases quantity demanded will falls and if
price of commodity falls quantity will increases.
Law of demand indicates only direction of
change in quantity demanded in response to
change in price but ELASTICITY OF DEMAND
states with how much or to what extent the
quantity demanded will change in response to
change in any determinants.

ELASTICITY - The
Concept
• If price rises by 10% - what happens to demand?
• We know demand will fall.
• By more than 10% ?
• By less than 10% ?
• Elasticity measures the extent to which demand
will change.

Meaning & Definition of
Elasticity of
Demand
Elasticity of Demand measures the extent to which quantity
demanded of a commodity increases or decreases in response to
increase or decrease in any of its quantitative determinants.
So, we have several types of elasticity of demand according to the
source of the change in the demand. For example, if the price is the
source of the change, we have the “price elasticity of demand”.
“The 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”. – Dr.
Marshall.

Elasticity of
Demand
According to the source of the change, the following types of
elasticity of demand can be mentioned:
• Price Elasticity of Demand
• Cross Elasticity of Demand (the elasticity in relation to the change of
the
price of other good and services)
• Income Elasticity of Demand
• Advertisement Elasticity of Demand (the elasticity in relation to the
advertisement expenditure)
According to the degree of the change in the demand, the
elasticity can be classified in:
• Perfectly Elastic
• Relatively Elastic
• Unitary Elasticity
• Relatively Inelastic
• Perfect Inelastic

Price Elasticity of
Demand
Price Elasticity of demand is a measurement of
percentage change in demand due to
percentage change in own price of the
commodity.
The price elasticity of Demand may be defined
as the ratio of the relative change in demand
and price variables.
e= Percentage/Proportional Change in Quantity Demanded
Percentage/Proportional Change in Price

Degree of Price Elasticity of
Demand
Five cases of elasticity of demand are studied
depending upon their degree:
• Perfectly Elastic
• Perfectly Inelastic
• Unitary Elastic
• Relatively Elastic
• Relatively Inelastic

Perfectly Elastic
Demand
When a small change in price of a product causes a major change in its
demand, it is said to be perfectly elastic demand. In perfectly elastic demand,
a small rise in price results in fall in demand to zero, while a small fall in
price causes increase in demand to infinity.
A perfectly elastic demand refers to the situation when demand is infinite at
the prevailing price.
In perfectly elastic demand, a small rise in price results in fall in demand
to zero,
while a small fall in price causes increase in demand to infinity.
The degree of elasticity of demand helps in defining the shape and slope of
a demand curve. Therefore, the elasticity of demand can be determined by
the slope of the demand curve. Flatter the slope of the demand curve,
higher the elasticity of demand.

Perfectly Inelastic
Demand
A Perfectly inelastic demand is one in which a change in price causes no
change in quantity demanded.
It is a situation where even substantial changesin price leave the
demand unaffected.
It can be interpreted from Figure that the movement in price from OP1 to
OP2 and OP2 to OP3 does not show any change in the demand of a
product (OQ).
The demand remains constant for any value of price.
Perfectly inelastic demand is a theoretical concept and cannot be applied in
a practical situation. However, in case of essential goods, such as salt, the
demand does not change with change in price. Therefore, the demand for
essential goods is perfectly inelastic.

Unitary Elastic
Demand
• When the proportionate change in demand
produces the same change in the price of the
product, the demand is referred as unitary
elastic demand. The numerical value for
unitary elastic demand is equal to one (ep=1).
• The demand curve for unitary elastic
demand is
represented as a rectangular hyperbola.

Relatively Elastic
Demand
Relatively elastic demand refers to the demand when the proportionate
change produced in demand is greater than the proportionate change in
price of a product.
Mathematically, relatively elastic demand is known as more than unit elastic
demand (ep>1). For example, if the price of a product increases by 20% and
the demand of the product decreases by 25%, then the demand would be
relatively elastic.
In this the demand is more responsive to the
change in price

Relatively Inelastic
Demand
Relatively inelastic demand is one when the
percentage change produced in demand is
less than the percentage change in the price
of a product.
For example, if the price of a product
increases by 30% and the demand for the
product decreases only by 10%, then the
demand would be called relatively inelastic.
The numerical value of relatively elastic
demand ranges between zero to one (ep<1).
Marshall has termed relatively inelastic
demand
as elasticity being less than unity.

The different types of price
elasticity of demand are
summarized in Table

Flatter the slope of the demand curve,
higher the elasticity of
demand.

Measurement of Price
Elasticity of
Demand
Measurement of Price Elasticity of Demand
Total Expenditure Method Proportionate Method Point
Elasticity of Demand Arc Elasticity of Demand

Total Expenditure
Method
Dr. Marshall has evolved the total expenditure method to measure the price
elasticity of demand. According to this method, elasticity of demand can be
measured by considering the change in price and the subsequent change in
the total quantity of goods purchased and the total amount of money spent
on it.
Total Outlay/ Total Expenditure = Price X Quantity Demanded There are
three possibilities:
If with a fall in price (demand increases) the total expenditure increases
or with a rise in price (demand falls), the total expenditure falls, in that
case the elasticity of demand is greater than one i.e. ED > 1.
If with a rise or fall in the price (demand falls or rises
respectively), the
total expenditure remains the same, the demand will be unitary elastic or ED
= 1.

Total Expenditure
Method
Table shows that when the price falls from Rs.
9 to Rs. 8, the total expenditure increases
from Rs. 180 to Rs. 240 and when price
rises from Rs. 7 to Rs. 8, the total
expenditure falls from Rs. 280 to
p
Rs. 240. Demand is elastic (E > 1) in
this case.
When with the fall in price from Rs. 6 to Rs. 5
or with the rise in price from Rs. 4 to Rs. 5,
the total expenditure remains unchanged at
Rs. 300, i.e., Ep = 1.
When the price falls from Rs. 3 to Rs. 2 total
expenditure falls from Rs. 240 to Rs. 180, and
when the price rises from Re. 1 to Rs. 2 the
total expenditure also rises from Rs. 100 to
Rs. 180. This is the case of inelastic or less
elastic demand, Ep < 1.
Price
Rs Per
Kg
Quantity
in Kgs
TE in
Rs
Ep
1 2 (1x2=3)
9 20 180 >>1
8 30 240
7 40 280
6 50 300 =1
5 60 300
4 70 300
3 80 240 <<1
2 90 180

Summarized Relationship In Total
Expenditure Method
Price TE Ep
Falls Rises >>1
Rises Falls
Falls Unchanged =1
Rises Unchanged
Falls Falls <<1
Rises Rises

Exampl
e
Price
(P)
Quantit
y (Q)
Exp.
(PxQ)
Price
(P)
Quantit
y (Q)
Exp.
(PxQ)
Price
(P)
Quantit
y (Q)
Exp.
(PxQ)
2 300 600 2 300 600 2 300 600
4 150 600 4 100 400 4 200 800
6 100 600 6 50 300 6 150 900
P E (No
Effect)
E=1
P E
E>1
P E
E<1

Questio
n
Ques 1: Price(1) = 2, Quantity (1)
= 10
Price (2) = 4, Quantity (2) = 5
E = ?

Solutio
n
Price Quantity Expenditure
2 10 20
4 5 20
P E (No Effect) E=1

Percentage or Proportionate
Method
This method is also associated with the name of Dr. Marshall.
Accordingto this method “Price elasticity of demand is the ratio of the
proportionate change in quantity demanded to proportionate change in
price.
It is also known as the Percentage Method, Flux Method, Ratio
Method, and Arithmetic Method. Its formula is as under:

Formul
a
Ep = Percentage Change in Quantity
Demanded Percentage Change in the
Price of the good

Percentage or Proportionate Method
(Ex 1)
Calculate the Price Elasticity of demand if the price fell by 10% causing
the demand to rise from 800 to 850 units.
Solution:

(Ex 2)
When Price of Commodity is Rs. 1, then Consumer spends Rs. 80 &
If the price of commodity is Rs. 20 then consumer spends Rs. 96.
Calculate the Elasticity of demand with Percentage Method.

(Ex 2)
Solutio
n:
Price Expenditure Quantity
1 80 80
2 96 48

Point Method or Geometrical
Method
Measures the price Elasticity of demand of different points on the
demand
curve .
This method was also suggested by Dr. Marshall
Used only with the reference to a linear demand curve.
Elasticity of demand at a point =

Point Method or Geometrical
Method

Arc
Method
We have studied the measurement of elasticity at a point on a demand
curve.
But when elasticity is measured between two points on the same
demand curve, it is known as arc elasticity.
In the words of Prof. Baumol, “Arc elasticity is a measure of the
average responsiveness to price change exhibited by a demand
curve over some finite stretch of the curve.”
Any two points on a demand curve make an arc.

Arc
Method
The area between P and M on the DD curve in Figure 11.4 is an arc
which
measures elasticity over a certain range of price and quantities.
On any two points of a demand curve the elasticity coefficients are likely
to be different depending upon the method of computation.

Why there is need of Arc
Method?

Arc
Method
Consider the price-quantity combinations P and M as given in
Table.
Demand Schedule
Point Price Quantity
P 8 10
M 6 12

Arc
Method
As per Percentage Method:
If we move from P to M, the elasticity of
demand is:
If we move in the reverse direction from M to P,
then
Thus this method of measuring elasticity at two points on a demand
curve gives different elasticity coefficients because we used a
different base in computing the percentage change in each case.
To avoid this discrepancy, elasticity for the arc method has been
developed

Arc
Method
Formula For Arc
Method:
Where,
P1 = Original Price P2 = New
Price
Q1 = Original Quantity
Demanded
Q2 = New QuantityDemanded

Arc
Method
On the basis of formula, we can measure arc elasticity of demand when
there is a movement either from point P to M or from M to P.
From P to M at P, p1 = 8, q1, =10, and at M, P2 = 6, q2 = 12
Applying these values, we get
Thus whether we move from M to P or P to M on the arc PM of the DD
curve, the formula for arc elasticity of demand gives the same
numerical value.

Income Elasticity of
Demand
Income elasticity of demand is the degree of responsiveness of quantity
demanded of a commodity due to change in consumer’s income, other
things remaining constant.
In other words, it measures by how much the quantity demanded
changes
with respect to the change in income.
The income elasticity of demand is defined as the percentage change in
quantity demanded due to certain percent change in consumer’s income.

Expression of Income Elasticity of
Demand
Where,
•EY = Elasticity of demand
•q = Original quantity
demanded
•∆q = Change in quantity
demanded
y = Original consumer’s
income

Example to Explain Income
Elasticity of
Demand
Suppose that the initial income of a person is Rs.2000 and quantity
demanded for the commodity by him is 20 units. When his income
increases to Rs.3000, quantity demanded by him also increases to
40 units. Find out the income elasticity of demand.
Solution:
Here, q = 100 units
∆q = (40-20) units = 20 units y = Rs.2000
∆y =Rs. (3000-2000) =Rs.1000
Hence, an increase of Rs.1000 in income i.e. 1% in income leads to a
rise of 2% in quantity demanded.

Types of Income Elasticity of
demand
Types of
Income
Elasticity of
Demand
Positive
Income
Elasticity Of
Demand E>0
Income
Elasticity
Greater than
Unity E>1
Income
Elasticity
Equal to Unity
E=1
Income
Elasticity
Less than
Unity E<1
Negative
Income
Elasticity Of
Demand E<0
Zero
Income
Elasticity
E=0

1. Positive income elasticity of
demand (EY>0)
If there is direct relationship between income of the consumer and
demand
for the commodity, then income elasticity will be positive.
That is, if the quantity demanded for a commodity increases with
the rise in income of the consumer and vice versa, it is said to be
positive income elasticity of demand.
For example: as the income of consumer increases, they consume more
of superior (luxurious) goods. On the contrary, as the income of
consumer decreases, they consume less of luxurious goods.
Positive income elasticity can be further classified into three types:
•Income Elasticity Greater than Unity E>1
•Income Elasticity Equal to Unity E=1
•Income Elasticity Less than Unity E<1

(A) Income elasticity greater than
unity (EY > 1)
If the
percentage
change in
quantity
demanded for a commodity is greater than percentage
change in income of the consumer, it is said to be income
greater than unity.
For example: When the consumer’s income rises by 3% and the
demand rises by 7%, it is the case of income elasticity greater
than unity.
In the given figure, quantity demanded and consumer’s income is
measured along X-axis and Y-axis respectively. The small rise in
income from OY to OY1has caused greater rise in the quantity
demanded from OQ to OQ1 and vice versa. Thus, the demand
curve DD shows income elasticity greater than unity.

(B) Income elasticity equal to unity
(EY = 1)
If the
percentage
chang
e
demanded for a
commodity
in
quantit
y
is
percentage change in
income
equal
to
of
th
e
consumer, it is said to be income elasticity equal to unity.
demand rises by 5%, it is the case of income elasticity equal to
unity.
measured along X-axis and Y-axis respectively. The small rise in
income from OY to OY1 has caused equal rise in the quantity
curve DD shows income elasticity equal to unity.

(C) Income elasticity less than
unity (EY < 1)
If the
percentage
chang
e
demandedfor a
commodity
in
quantit
y
is less
than
percentage change in income of the consumer, it is said to be
income greater than unity.
demand rises by 3%, it is the case of income elasticity less than
unity.
measured along X-axis and Y-axis respectively. The greater rise in
income from OY to OY1has caused small rise in the quantity
curve DD shows income elasticity less than unity.

2. Negative income elasticity of
demand ( EY<0)
If there is inverse relationship between income of the consumer and
demand for the commodity, then income elasticity will be negative. That
is, if the quantity demanded for a commodity decreases with the
rise in income of the consumer and vice versa, it is said to be
negative income elasticity of demand.
For example: As the income of consumer increases, they either stop or
consume less of inferior goods.
measured
along X-axis and Y-axis
from OY to OY1 the
respectively. When the
consumer’s income quantity
demanded of inferior
goods
rise
s
fall
s
from OQ to OQ1 and vice versa. Thus, the demand curve DD shows
negative income elasticity of demand.

3. Zero income elasticity of demand
( EY=0)
If the quantity demanded for a commodity remains constant with
any rise or fall in income of the consumer and, it is said to be zero
income elasticity of demand.
For example: In case of basic necessary goods such as salt, kerosene,
electricity, etc. there is zero income elasticity of demand.
measured along X-axis and Y-axis respectively. The consumer’s income
may fall to OY1 or rise to OY2 from OY, the quantity demanded remains
the same at OQ. Thus, the demand curve DD, which is vertical straight
line parallel to Y-axis shows zero income elasticity of demand.

Cross Elasticity of
Demand
The measure of responsiveness of the demand for a good towards
the change in the price of a related good is called cross price
elasticity of demand. It is always measured in percentage terms.
With the consumption behavior being related, the change in the
price of a related good leads to a change in the demand of another
good.
Related goods are of two kinds, i.e. substitutes and complementary
goods.

Cross Elasticity of
Demand
In case the two goods are substitutes for each other like tea
and coffee, the cross price elasticity will be positive, i.e. if the
price of coffee increases, the demand for tea increases.
On the other hand, in case the goods are complementary in
nature like pen and ink, then the cross elasticity will be negative,
i.e. demand for ink will decrease if prices of pen increase or vice-
versa.
It can be expressed as:

Cross Elasticity of
Demand
Definition:
“The cross elasticity of demand is the proportional change in the
quantity of X good demanded resulting from a given relative change in
the price of a related good Y” Ferguson
“The cross elasticity of demand is a measure of the responsiveness of
purchases of Y to change in the price of X” Leibafsky
In case the two goods are substitutes for each other like tea and coffee,
the cross price elasticity will be positive, i.e. if the price of coffee
increases, the demand for tea increases.
On the other hand, in case the goods are complementary in nature like
pen and ink, then the cross elasticity will be negative, i.e. demand for
ink will decrease if prices of pen increase or vice-versa.

Cross Elasticity of
Demand
Substitute Goods:
In case the two goods are substitutes for each other like tea and coffee,
the cross price elasticity will be positive, i.e. if the price of coffee
increases, the demand for tea increases.
Complementary Goods:
On the other hand, in case the goods are complementary in nature like
pen and ink, then the cross elasticity will be negative, i.e. demand
for ink will decrease if prices of pen increase or vice-versa.

Types of Cross Elasticity of
Demand
Types of
Cross
Elasticity of
Demand
Positiv
e
Negativ
e
Zer
o

Positive Cross Elasticity of
Demand
When goods are substitute of each other
then
cross elasticity of demand is positive.
In other words, when an increase in the
price of Y leads to an increase in the
demand of X.
For instance, with the increase in price of
tea, demand of coffee will increase.
In figure quantity has been measured on OX-axis and price on OY-axis.
At price OP of Y-commodity, demand of X-commodity is OM. Now as
price of Y commodity increases to OP1 demand of X-commodity
increases to OM1 Thus, cross elasticity of demand is positive.

Negative Cross Elasticity of
Demand
In case of complementary goods, cross
elasticity of demand is negative.
A proportionate increase in price of one
commodity leads to a proportionate fall in
the demand of another commodity
because both are demanded jointly.
In figure quantity has been measured on OX-axis while price has been
measured on OY-axis. When the price of commodity increases from OP
to OP1 quantity demanded falls from OM to OM1. Thus, cross elasticity
of demand is negative.

Zero Cross Elasticity of
Demand
Cross elasticity of demand is zero when
two goods are not related to each other.
For instance, increase in price of car does
not effect the demand of cloth. Thus, cross
elasticity of demand is zero.

Advertising and Promotional
Elasticity of Demand

Advertising Elasticity of
Demand
Advertising elasticity of demand refers to the proportionate
change in demand of a commodity due to proportionate
change in advertising expenses.
Advertising elasticity is a measure of an advertising
campaigns effectiveness in generating sales.
Formula:

Types Of Advertising Elasticity of
Demand
•Perfectly Elastic Advertising
elasticity
•Perfectly Inelastic Advertising
Elasticity
•Highly Elastic Advertising Elasticity
•Unitary Elastic Advertising Elasticity
•Highly Inelastic Advertising
Elasticity

Perfectly Elastic
AED
When the demand for a
product changes –
increases or
decreases even
when there is nochange in
x advertising expense.
Perfectly
elastic
curve
Expense
D
demand

Perfectly Inelastic
AED
When a change in
advertising
expense , doesn’tlead to
any
change in quantity
demanded
,
it is known as
perfectly
inelastic demand.
D
demand
Perfectly
inelastic
curve
Advertising
Expense

Relatively Elastic
AED
When the proportionat
e
change indemand ismore
than
the proportionate changes
in
advertising expense , it
i
s
known asrelatively
elastic
Relatively elastic
curve
Advertising
Expense
demand

Unitary Elastic
AED
When the proportionate
change in demand is equal
to proportionate changes in
advertisingexpense price, it
is
known as unitary
elastic demand.
Unitary
AED
demand
Advertising
Expense

Relatively Inelastic
AED
When the proportionat
e is
les
s
chang
e
than
in
deman
d the
proportionat
e
advertisin
g
changes
expense ,
in
it is known
as
relatively inelastic
deman
d
Relatively
inelastic
demand
curve
demand
Advertising
Expense

Uses of Elasticity of
Demand for Managerial
Decision Making

1. Determination of
Price
The primary objective of any firm is to earn profit or increase
revenue. Therefore, increasing price of its products to
maximize profit is one of the primary concerns of producers.
However, during the course of increasing price, the
producers must not forget that demand and price share
inverse relationship. They must be aware that demand falls
with rise in price. And thus, they must increase price of
their commodity to that level where their desired or optimal
profit is still achievable.

1. Determination of
Price
For example: In the table given below are shown three
cases (I, II & III) of a restaurant that sells burger.

1. Determination of
Price
In the above table, we can see that when price of the burger was $10
per unit, its demand in the market were 100 units per day, causing the
firm profit of $300.
When the firm increased the price to $10.2, its demand fell by 10 units
per day.
As a result, the firm gained profit of $288, causing reduction of $12 in
initial profit. In the same way, when the price is increased to $11 per
unit, there is once again decrease in demand. The new demand in
market is 85 units per day and the new profit is $340.
From the example, it is clear that producers must always analyze
elasticity of their product and must evaluate the impact of changes in
price on the total revenue and profit of their firm.

2. Wage
Determination
If a commodity is of inelastic nature, the labor can force the
employer to increase their wage through extreme ways like
strike. As a result, the company will have to consider the
demands of labor in order to meet the demand of
consumers for the inelastic goods.
However, if the commodity is of elastic nature, labor unions
and other associations cannot force the employers to raise
wage as the producers can alter the demand of their
products.

3. Importance in International
Trade
We have already known that change in price cannot bring drastic
change in demand of the product in case of inelastic commodity. But
even a slight change in price can cause huge effect on demand of
elastic commodity.
We have also known that higher price can be charged for inelastic
goods and lowest possible price must be set for elastic goods.
Taking into account the above information, a country may fix higher
prices for goods of inelastic nature. However, if the country wants to
export its products, the nature (elasticity/inelasticity) of the commodity
in the importing country should also be considered.
For example: Rice maybe an inelastic product for China and thus
exports around the world at the price “x”. But, if rice is price elastic in
the US, China will be forced to decrease the price from the initial value
of “x” to be able to sell the product in American market.

4. Importance to Finance
Minister
Price elasticity of demand can also be used in the taxation
policy in order to gain high tax revenue from the citizens.
One of the ways would be for the government to raise tax
revenue in commodities which are price inelastic.
For example: Government could increase the tax amount in
goods like cigarettes and alcohol. Given how these are the
commodities people choose to purchase regardless of the
price tag, the tax revenue would significantly rise.
On the other hand, in case of a commodity with elastic
demand high tax rates may fail to bring in the required
revenue for the government.

5.Price
Discrimination
The situation where a single group or company controls all or almost all
of market for a particular good or service is called monopoly. The
monopolistic market lacks competition. Thus, the goods or services are
often charged high prices in such market.
If the product is inelastic (less or no effect on demand with change in
price), the producer can earn profit by setting high price. However, if the
product is elastic (highly affected by even slightest change in price), the
producer must set low or at least reasonable price so that the
consumers are attracted to buy the goods.
For example: Fuel is necessity of consumers. Therefore, monopolist
who runs the market of fuel can generate profit even by setting high
price of fuel.

6. Price Determination of Joint
Products
Joint products are various products generated by a single production
procedure at a single time. Sheep and wool, cotton and cotton seeds,
wheat and hay, etc. are some examples of joint products.
However, since they are two different products, we cannot sell them at
the same price in the market. Price elasticity of demand plays important
role in determining the prices of these joint products.
Let us suppose, there has been bumper production of cotton this
season. As a result, huge amount of cotton as well as cotton seeds
have been produced.
Cotton has wide scope in the market as it can be used for different
purposes. The producers of cotton can gain maximum profit by setting
high price of cotton, as demand of cotton in market is not easily altered.
But cotton seeds have limited scope, so it is an elastic product. If the
business does not decrease the price, then demand will be less.
By setting a high price for cotton (inelastic product) and low price for

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