Q.

1 Difference between

Sr. Price elasticity of Income elasticity of Cross elasticity of

no. demand demand demand
Price elasticity of demand The income elasticity of The cross elasticity of
1. (PED) is defined as the demand measures the demand and cross
measure of responsiveness in responsiveness of the price elasticity of
the quantity demanded for a demand of a good to the demand measures the
commodity as a result of change in the income of responsiveness of the
change in price of the same the people demanding the demand of a good to a
commodity good change in the price of
another good.
2. It is percentage change in It is calculated as the ratio It is measured as the
quantity demanded by the of the percent change in percentage change in
percentage change in price of demand to the percent demand for the first
the same commodity change in income good that occurs in
response to a
percentage change in
price of the second
good
3. Ed= % Change in quantity Ey = % change in demand E A,B = % Change in
______________________ Demand of Product A
demand % change in Income % change in price of
________________________ product B
% change in Price
4. Types :

Unitary elastic demand

Perfectly elastic demand
Perfectly inelastic demand
Relatively elastic demand
Relatively inelastic demand
Q 2. What are the methods to calculate price elasticity of demand?

Ans:
Consumer in the market economy are influenced by various factors in deciding
what to buy. One of these factors is price and the law of demand that defines
the typical relationship between price and quantity demands states that the
consumer will demand more of a particular product at a lower price, and less at
a higher price. However, the price elasticity of demand examines how much
demand expands in response to change in price.

Followings are the methods to calculate price elasticity:

1) Ratio or percentage method:

Price elasticity of demand is measured by the ratio of percentage change in
quantity demanded and percentage change in price, thus
Proportionate change in quantity demanded (∆ Qx)
Price elasticity = ____________________________________________________
Proportionate change in price (∆ Px)

Change in Qx Change in Px
Ep = _______________ ÷ _______________
Original Qx Original Px
∆ Qx Px
Ep = _____ × ______
Qx ∆ Px

For example:

The price of rice falls from Rs. 10 to Rs. 8 per kg and quantity demanded
increases from 100 to 120 quintals. The n price elasticity of demand is as
under
∆ Qx Px
Ep = _____ × ______ p
Qx ∆ Px

20 10 D1
Ep= ___ × ____
100 2

200
Ep= ____ = 1 Q
200
2) Total outlay method:
Total outlay method refers to the total expenditure on the good after its price
Changes. Total outlay is obtained by multiplying the number of units
sold by the price of a product i.e. (Total revenue = Total unit sold X
price)

Sr. Price Quantity of Total outlay Price elasticity

No. (Rs.) mangoes of demand
demanded in
units
I 15 200 3000 Ep > 1
12 300 3600
II 15 200 3000 Ep= 1
12 250 3000
III 15 200 3000 Ep < 1
12 210 2520

Y
P Ep > 1

Q
Price (Rs.)
Ep = 1

R
Ep < 1
S X
Total Outlay

Ep >1 if total outlay of a commodity increases after a fall in price of a

commodity then price elasticity of demand is elastic. Price elasticity is grater
than one over PQ range of the curve.

Ep=1 if total outlays remains constant, even after a fall in price of commodity,
then, it is the case of unit elastic demand, price elasticity or demand over QR
range of the curve is equal to one.

Ep < 1 if the total outlay decreases, after a fall in price then the elasticity of
demand is less then one. Price elasticity is less than one over RS range of
demand curve.

3) Point method

When we measure elasticity of demand at a point on linear demand curve which

intersects both axes, it is linear demand curve which measuring elasticity of
demand. The demand curve has a negative slops but price elasticity varies
from point to point.

Ep = Lower segment of demand curve

 Upper segment of demand curve

Y
D1

P1 M1

P2 N M2

X
O Q1 Q2 D2

D1 D2 is straight line demand curve. When price decreases from OP1 to OP2 demand
extends from O Q1 to O Q2. Let us consider two points on demand curve i.e M1 and
M2 to measure elasticity of demand through point method.

Ep = proportionate change in demand = ∆Q X P

Proportionate change in price ∆P Q
In This fig

Ep = Q1 Q2 X OP1 (1)
P1 P2 OQ1

As per the fig. q1q2 = NM2, P1P2 = M1 N, OP 1= M1Q1, OQ1 = P1M1

EP= NM2 X M1Q1

M1N OQ1 (2)

Hence, NM2 = Q1D2

M1N M1Q1

Substitute, Q1D2 in place of NM2 in equation (2)

Q1M1 M1N

We get Ep= Q1D2 X M1Q1

M1Q1 OQ1

EP = Q1D2
OQ1

Now OQ1 is equal to P1M1 then Ep= Q1D2

P1M1

Taking Q1D2 and P1M1 as the base we have tow triangles ∆ P1M1D1 and ∆ Q1D2M1
by geometrical rules these tow triangles are equal. Therefore their sides are
proportionate
We can state Ep= Q1D2 = M1Q1 = M1D2
P1M1 P1D1 M1D1
Ep= M1 D2 = Lower segment of he demand of point M1
M1D1 Upper segment of the demand of point M1

Elasticity of point M1 = M1D2

M1D1
Thus elasticity of demand varies from point to point on a straight line demand curve.
Elasticity will gradually decrease as we move towards D2 as the lower segment will
become smaller.

4) Arc method of price elasticity of Demand:

Are elasticity of demand measures the price elasticity of demand over a range on the
demand curve rather than a point on demand curve. In reality we often come across a
situation where price changes are substantial.

Change in quantity demanded

Original quantity + new quantity
2
Arc elasticity of Demand = __________________________________________
Change in Price
Original price + New price
2

If price of commodity X is Rs. 5 then 500 units of X goods are sold. When price falls to
Rs. 4 the 700 units are sold. Arc elasticity of demand is worked as under

∆Q P1 + P2
Arc elasticity of demand = ____ X _________
∆P Q1 + Q2

= 200 5+4 = 200 9 1800

_____× _______ ____x _____= ________
1 500+700 1 1200 1200

=3 = 1.5
2
Q 3. Discuss all the importance of the concept elasticity of demand for the
manager?

There is need to understand price elasticity of demand for the goods they sell in order
to decide on optimal pricing policy. If demand were relatively elastic, the firm would
know that lowering the price would expand the volume of sales thus increasing total
revenue. On the other hand, if demand were relatively inelastic the firm could increase
the price, which would also lead to an increase in total revenue. Awareness of the
elasticity of demand in different price ranges is important for determining the best
pricing policy and in deciding whether to change prices. To that extent, business often
engage in statistical market research in order to determine consumer preferences, and
in particular, the price elasticity of demand for the product.

Price elasticity of demand describes the way in which the demand for a product
response to a change in its price. If small change in price leads to a large change to a
demand, a product is said to be highly price elastic. Many consumer goods such
as calculators, DVD players and washing machine are price elastic. If the demand for
a product shows little response to change in price, the product is said to be price
inelastic. Essential goods such as basic foods (e.g. bread, medicine) and fuel tend to
be price inelastic.

Regarding the importance of the concept of elasticity of demand, it must be pointed

out that the concept is useful to the business managers as well as government
managers. Elasticity measures help the sales manager in fixing the price of his
product. The concept is also important to the economic planners of the country. In
trying to fix the production target for various goods in a plan, a planner must estimate
the likely demand for goods at the end of the plan. This requires the use of income
elasticityconcept.
The price elasticity of demand as well as cross elasticity would determine the
substitution between goods and hence useful in fixing the output mix in a production
period. The concept is also useful to the policy makers of the government, in particular
in determining taxation policy, minimum wages policy, stabilization programmer for
agriculture, and price policies for various other goods (where administered prices are
used).
The managers are concerned with empirical demand estimates because they provide
summary information about the direction and proportion of change in demand, as a
result of a given change in its explanatory variables. From the standpoint of control
and management of external factors, such empirical estimates and their
interpretations are therefore, very relevant.

In market economics consumer can exercise their rights to buy what ever they want
however consumer will only purchase certain goods in certain quantities at certain
prices, if there is price change, quantity demanded will adjust correspondingly. This is
where price elasticity of demand comes in, measuring the responsiveness of the
quantity demanded to changes in price using methods such as the total outlay
method. Finally, this information is important to business, which need to find their
optimal pricing policy in order to achieve their goal of business of maximize the profits.
Q 4. Discuss consumer equilibrium with the help of utility analysis and
indifference curve analysis?

The equilibrium level is that at which consumer maximizes his or he buys such
combination of goods which leaves him with tendency not to rearrange or alter
his purchase i.e. consumer is enjoying topmost level of satisfaction. In the
indifference curve analysis to be on the equilibrium level, the consumer tries to
maximize his satisfaction by reaching on highest possible IC. To show this
equilibrium the following assumption are considered.

Good Y R IC 5

N E IC4
IC3
IC2

S IC1

O M Good X
Assumptions:

1. a consumer is a rational human being

2. A consumer has given indifference map which shows his scale of
preference.
3. The consumer intends to buy combination of good X and good Y
4. The consumer has fixed amount of money income which can be spent on
two goods X and Y
5. Goods are homogenous and divisible
6. Prices of good X and Y are given and are constant.
7. Consumer scale of preference remains constant due to his definite tastes
and preference.
To explain the consumer’s equilibrium, we have to show both the IC map and
the price line simultaneously, showing the scale of preference. Indifference
map indicates consumer’s scale of preference between various combinations of
two goods and the price line shows a buying capacity of the consumer with
given price of good X and good Y. Consumer cannot select any such
combination which is beyond price line.

In the above figure goods x and y are measured along X axis and Y axis
respectively. With the given money income the consumer will select any such
combination which lies on the price line PL. Similarly, since the consumer is a
rational, he tries to maximize his satisfaction, hence he will try to reach the
highest possible IC in the indifference map.
It is clear from the above fig that there are five different ICs in the indifference
map. There are several points like R, E and S which lies on the price line, PL.
it means consumer can afford to