Ponder

Law of demand gives only the direction of change in quantity demanded in response to a given change in price.

How will you find the magnitude of change??

Elasticity of Demand
Topics Covered Types of Elasticity Price Elasticity Degrees of Price Elasticity Methods of Measuring Elasticity Determinants of Price Elasticity of Demand Revenue and Price Elasticity of Demand

Elasticity of Demand
Elasticity of demand measures the degree of responsiveness of the quantity demanded of a commodity to a given change in any of the determinants of demand.

Types of Elasticity Price elasticity Income elasticity Cross elasticity Promotion/advertising elasticity

Price Elasticity
price elasticity of demand measures the proportion change in quantity demanded of a commodity to a given change in price

Remember: by price, we imply own price of the demand, designated as ep or e

Degrees of Price Elasticity

Perfectly Elastic Demand: elasticity

ep = ep = 0

Perfectly Inelastic Demand: elasticity

Unitary Elastic: elasticity

ep = 1
ep < 1

Relatively Inelastic: elasticity Relatively Elastic: elasticity

ep > 1

Degrees of price elasticity

Perfectly Elastic
P Ep= 100 100 0 P 100 200 0 100 P ep>1 150 100 0 ep<1 Q 0

Perfectly Inelastic
P
200 Ep=0 P

Unitary Elastic

Ep=1

110
100 0 100 200

4 5

Highly Elastic

Highly Inelastic

Methods of Measuring Elasticity

Ratio Method/percentage method/proportionate Method Arc Elasticity Method Total Outlay Method Elasticity at different points on a linear demand curve

Ponder!

Why is the impact of price change different for different commodities???

Determinants of elasticity
Nature of the commodity Availability and proximity of substitutes Alternative uses of the commodity Proportion of income spent on the commodity Time Items of addiction etc.

Importance of elasticity of demand

Determination of price Basis of price discrimination Determination of rewards for factors of production Government policies of taxation

Income elasticity
Income elasticity of demand measures the degree of responsiveness of demand for a commodity to a given change in consumers income. Denoted as ey

ey =

% change in quantity demanded of commodity X % change in income of consumer

Degrees of Income Elasticity

Positive Income Elasticity (eg.??) Unit elastic More elastic Less elastic Perfect elastic Perfect inelastic

Zero Income Elasticity (eg.????) Negative Income Elasticity (eg.???)

Think out of Box

Which type of goods would a firm prefer to produce: those with positive income elasticity or negative income elasticity???

Cross elasticity of demand

Cross elasticity of demand of a commodity X measures the degree of responsiveness of its demand to a given change in the price of another related commodity Y Denoted as ec

ec =

% change in quantity demanded of commodity X % change in price of commodity Y

Remember
Related goods can either be complements (joint demand) or substitutes (competing demand).

Degrees of cross elasticity Positive cross elasticity Think of the goods which have positive cross elasticity. Why? Negative cross elasticity Think of the goods which have positive cross elasticity. Why?

Think out of the Box

Is zero cross elasticity possible???

Promotional Elasticity of demand

Promotional elasticity of demand measures the degree of responsiveness of demand to a given change in advertising expenditure. Denoted as ea
% change in QD/sales of commodity X

ea =
% change in advertising expenditure

Promotional Elasticity of demand

When ea >1, a firm should go for heavy expenditure on advertisement

When ea<1, a firm should not go for heavy expenditure on advertisement