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INTRODUCTION

Demand is desire backed by willingness to pay and ability to

pay i.e. a wish to have a commodity does not become demand. A

person wishing to have a commodity should be willing to pay for it

and should have ability to pay for it. Thus a desire becomes demand

if it is backed by willingness to pay and ability to pay. Demand is

meaningless unless it is stated with reference to a price.

Decisions regarding what to produce, how to produce and for

whom to produce are taken on the basis of price signals coming from

the market. The law of demand explains inverse relationship

between price and quantity demanded. When price falls quantity

demanded of that commodity will increase. The deficiency of law of

demand is removed by the concept of elasticity of demand.


MEANING AND DEFINITION
OF
ELASTICITY OF DEMAND

The term elasticity was developed by Alfred Marshall, and is

used to measure the relationship between price and quantity

demanded. The law states that 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.

Elasticity means responsiveness. Elasticity of demand refers

to the responsiveness of quantity demanded of a commodity to

change in its price.

According to E.K. Estham, “elasticity of demand is a measure of the

responsiveness of quantity demanded to a change in price”.


IMPORTANCE
OF
THE CONCEPT ‘ELASTICITY’

The concept f elasticity of demand plays a crucial role in business-

decisions regarding fixing of price with a view to make larger profit. For

instance, cost of production is increasing the firm would want to pass the rising

cost on to the consumer by raising the price. Firms may decide to change the

price even without any change in the cost of production. But whether raising

price following the rise in cost or otherwise proves beneficial depends on:

a) The price elasticity of demand for the product, i.e. how high or low is the

proportionate change in its demand in response to a certain percentage change in its

price.

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.
Elasticity of demand establishes the quantitative relationship between

quantity demanded and price or other demand determinants.


TYPES OF ELASTICITY
These are three types of elasticity:-

1. Price elasticity
2. Income elasticity
a. Zero income elasticity
b. Negative income elasticity
c. Positive income elasticity
3. Cross elasticity

1. Price Elasticity

Price elasticity of demand may be defined as the degree of

responsiveness of quantity demanded of a commodity in response to change in

its price i.e. it measures how much a change in price of a good affects demand

for that good, all other factors remaining constant. It is calculated by dividing the

proportionate change in quantity demanded by the proportionate change in

price.

EP= Proportionate change in quantity demanded


Proportionate change in price
2. Income elasticity

Income elasticity of demand measures how much a change in income affects

demand for that commodity if the price and other factors remains constant.

EY= Proportionate change in quantity demanded


Proportionate change in income
A product with an income elasticity of more than one will experience a
growth in demand that is higher than growth in consumer’s income. Luxury
goods tend to have relatively high income elasticity. Low quality goods have
negative income elasticities, as people stop buying them when they can afford
to.

There are three types of income elasticity –

Zero income elasticity – Here a change in income will have no effect of


quantity demanded. For example: - salt, matches, cigarettes.

Negative income elasticity – Here an increase in income leads to a decrease


in quantity demanded. This happens in inferior goods.

Positive income elasticity – In this an increase in income will leads to an


increase in quantity demanded. For most goods income elasticity is positive.

3. Cross elasticity

This measures the change in demand for a commodity due to change in

price of another commodity.

ED= Percentage change in quantity demanded of commodity A


Percentage change in price of commodity B

If the goods having substitutes the cross elasticity is positive i.e. an

increase in the price of X will result in an increase in sales of Y. If the goods are

complementary and increase in the price of one commodity will depress the

demand for the other. So cross elasticity will be negative. If the goods are

unrelated cross elasticity will be zero. Because however much the price of one

commodity increased demand for the other will not be affected by that increase.
There exist another two types elasticity viz.

Elasticity of price expectation and

Advertisement elasticity

4. Advertisement elasticity or Promotional elasticity

The expenditure n advertisement and other sales promotion activities


does help in promoting sales, but not in the same degree at all levels of the total
sales. The concept of advertisement elasticity is useful in determining the
optimum level of advertisement expenditure. It may be defined as, “the
responsiveness of demand t to changes in advertising or other promotional
expenses”.

EA = Proportionate change in sales


Proportionate change in advertising and other promotional expenditure

5. Elasticity of price expectations

The price expectation elasticity refers to the expected change in future


price as a result of change in current price of a product.

ex = pf / pf pf x pc
==
pc/pc pc pf

Where Pc and Pf are current and future price. The coefficient ex gives
the measure of expected percentage change in future price as a result of 1
percent change in present price. If ex > 1 it indicates the future change in price
will be greater than the present change in price. If ex=1, it indicates that the
future change in price will be equal to the change in current price. In ex > 1, the
sellers will sell more in the future at higher prices.
FACTORS INFLUENCING

PRICE ELASTICITY OF DEMAND

1. Nature of commodity

Elasticity depends on whether the commodity is a necessity, comfort or


luxury. Necessities of life have inelastic demand and comforts and luxuries
have elastic demand.

2. Availability of substitutes

Goods with substitutes have elastic demand and goods without


substitutes have inelastic demand. For example: coffee and tea are substitutes.
If price of tea increases, people may switch over to coffee. If price of coffee
raises people may shift to tea. The demand of salt is inelastic.

3. Uses of the commodity

Certain goods can be put to many uses. Example – electricity. Such


goods have elastic demand because as the price decreases, they will be put to
more uses.

4. Proportion of income spent on commodity

For some goods, consumers spend only a small part of their income. The
demand will be inelastic. For eg: - salt and matches
5. Price of goods

Generally cheap goods have inelastic demand and expensive goods

have elastic demand.

6. Income of consumers

Very rich people have inelastic demand for goods and poor people have

elastic demand. Because rich people will buy the commodity at all levels of

prices where poor people there is a change in quantity of consumption

according to change in price.

7. Time period

Elasticity would be more in the long run than in the short run. Because in

the long run consumers can adjust their demand by switching over to cheaper

substitutes. Production of cheaper substitutes is possible only in the long run.

8. Distribution of income and wealth in the society

If there is unequal distribution of income, the demand of commodities will

be relatively inelastic. If the distribution of income and wealth in the society is

equal there will be elastic demand for commodities.


DEGREES OF ELASTICITY

Since the responsiveness of quantity demanded varies from commodity

to commodity and from market to market, it is important to study the degrees of

price elasticity. We can identify five degrees of elasticity. They are: -

1. Perfectly elastic demand

2. Perfectly inelastic demand

3. Unitary elastic demand

4. Relatively elastic demand

5. Relatively inelastic demand

1. Perfectly elastic demand

Perfectly elastic demand is the situation where a small change in price

causes a substantial change in quantity demanded i.e. a slight decline in price

causes an infinite increase in quantity demanded and a slight increase in price

leads to demand contracting to zero. The demand is hypersensitive and the

elasticity of demand is infinite. Demand curve becomes a horizontal straight line

parallel to x-axis.
Y

Price
D ep = 2

X
0 Qty demanded

2. Perfectly inelastic demand

It is the situation where changes in price cause no change in quantity


demanded. Quantity demanded is non-responsive or inelastic. Demand curve is
a vertical line parallel to Y-axis and the elasticity of demand is zero.

P1 ep = 0
Price

P2

Quantity demanded M

It is clear that the price is OP or OP1 or OP2. The quantity demanded


remains unchanged at OM.
3. Unitary elastic demand

It refers to that situation where a given proportionate change in price is

accompanied by an equally proportionate change in quantity demanded. For

example, if price changes by 10%, quantity demanded also changes by 10%.

∴ ep= 10/10 = 1

ie; elasticity will be equal to one. The demand curve is a rectangular


hyperbola.

P ep =1
Price

P1

0 N N1 X

Quantity demanded
4. Relatively elastic demand

Demand is said to be relatively elastic when a given proportionate

change in Price causes a more than proportionate change in quantity

demanded.

P ep >1
Price

P1

0 N N1 X

Quantity demanded
5. Relatively Inelastic demand

Demand is relatively inelastic when a given proportionate change in

price causes a less than proportionate change in quantity demanded. Demand

curve will be a very steep curve. Elasticity is less than 1. For example, If price

changes by 20% quantity demanded changes by 10%

Then ep = 10/20 = .5 ie; ep<1

Y D

P1 ep =1
Price

0 N N1 X
Quantity demanded

Of the five degrees of elasticity perfectly elastic and perfectly

inelastic are extreme cases i.e. rarely found in actual life. Unitary elasticity,

relatively elastic and relatively inelastic demand are the most widely used price

elasticties.
MEASUREMENT OF
ELASTICITY OF DEMAND

Important methods to measure the elasticity of demand are: -

1. Proportional or percentage method


2. Expenditure or Outlay method
3. Geometric or point method

These are the commonly used methods.

1. Proportional method or Percentage method

Under this method the elasticity of demand is measured by the ratio

between the proportionate or percentage change in the quantity demanded and

proportionate or percentage change in price. It is also known as formula

method.

Ep= Proportionate change in quantity demanded

Proportionate change in price

∆q= ∆p
q p

= p X ∆q
q ∆p
ep is the price elasticity
∆ q is the change in quantity demanded
∆p is the change in price
q is the initial quantity
p is the initial price
For example:
Price of A Quantity demanded of A
5 10
4 15
When price of A is Rs.5 quantity demanded is 10. When price falls to Rs.4
quantity demanded rises to 15.
Here ∆ p = 1, ∆ q= 5
Initial price = 5, Initial quantity = 10
ep = p X ∆q
q ∆p
= 5 X 5
10 1
= 2.5

Elasticity is greater than one (relatively elastic) if price elasticity is equal

to one, it is unitary elastic demand. If elasticity is less than one, it is relatively

inelastic demand. If elasticity is more than one, it is relatively elastic demand. If

elasticity is zero, it is perfectly inelastic demand. If elasticity is infinity, it is

perfectly elastic demand.

2. Expenditure or Outlay method

By this method elasticity is measured by estimating the change in price

that leads to a change in quantity demanded causes changes in total


expenditure incurred on commodity. According to seller’s total expenditure

means total revenue. So this method is also known as total revenue method.

By looking at variation in total expenditure, price elasticity can be calculated.

Quantity Total Expenditure


Price (P
Demanded (Q) (P x Q)
18 3 54 e>1
15 4 60
e=1
12 5 60
e <1
9 6 54

In this table a fall in price leads to a more than proportionate increase in

quantity demanded increase in total expenditure. Conversely, a fall in price

leads to a less than proportionate increase in quantity demanded results in

decrease in total expenditure. A fall in price leads to a proportionate increase in

quantity demanded result in total expenditure remaining constant.

Y
A
e>1
B

e=1

C
e<1
L

0 X
Total Expenditure
In this figure price is on the vertical axis and total expenditure on horizontal

line. As the price falls and total outlay increases, elasticity is greater than 1. We

find elasticity greater than 1 in the CB portion of the total outlay curve. In BA,

total expenditure remains the same while price is falling. Therefore elasticity is

equal to 1. In AL the price is falling and total expenditure is also falling. From A

to L the curve is bending towards the origin. So elasticity is less than one

If total expenditure increases, elasticity >1

If total expenditure decreases, elasticity<1

If total expenditure remains constant, elasticity=1

3. Geometric method or Point or Straight line method

This method is used to measure the change in quantity demanded in

response to a very small change in price. If demand curve is a straight line,

elasticity at any point on the straight line can be calculated using the point

method.

When demand curve is a horizontal straight line parallel to x axis elasticity is

equal to infinity. It is perfectly elastic demand. When demand curve is a vertical

straight line parallel to y axis elasticity is equal to zero. It is perfectly inelastic

demand. For calculating elasticity at any point on a downward slopping demand

curve, we have to extend the demand curve to touch the x axis and y axis.
Then the point at which elasticity is to be known has to be marked on

demand curve dividing it into upper segment and lower segment.

ep = lower segment
upper segment

a ep=2

ep>1

ep=1
PRICE

ep<1

ep=0
0 X
Qty demanded e

4. Arc method

Arc method is not so important that it is applicable only when there are very

small change in price and demand.


Using of Elasticity Concept in Business

We are the company which produce a commodity x. We earn maximum

profit by selling 80% of commodities at the rate of Rs.20/-.

STAGE I – At the time of commencement


D

20
PRICE

0 X
80
Qty

Suddenly we have to face a decline in demand. Demand falls by 10% and

the current demand deceases from 80% to 70%..

STAGE II – Decrease in demand


D

20
PRICE

0 70 Qty 80 X

At this time we have to reduce the price by Rs. 18/- instead of Rs. 20/- to

increase the demand and demand increases from 70% to 75%.


STAGE III – Current position of our company

D1
20

PRICE D

D1
0 70 75 80 X
Qty

Reasons for decline in demand

There are certain reasons for the sudden decline of demand for our

commodity.

1. Availability of cheap substitutes

The main reason is the availability of cheap substitutes in the market i.e.

more substitutes is available in the market at low price. So that people buy

more of that commodity and because the demand for our commodity falls.

Substitution effect means change in demand due to substituting one commodity

for another.
When price of a commodity falls the cheaper commodities will be substituted

in the place of dearer commodities. Thus price of the commodity falls more of it

will be demanded and the consumer uses it as a substitute for high priced

commodities.

2. Lack of Advertisement

Lack of Advertisement is also a reason for the declining demand for goods.

In a highly competitive market advertisement is very important and it also affect

the change in demand. The main objective of advertisement is to create

additional demand by attracting more consumers to our product. So we must

advertise well to increase our demand of our product. ---2584285

3. Technological progress

Technological progress also affect demand for a commodity. Inventions and

discoveries bring new things in the market. So people will not demand older

things. So we must use more technological devices to improve the demand for

our product.----9703252205
4. Lack of demonstration

Lack of demonstration also brings out our commodity to a fall in demand i.e.

people get motivated or they were attracted by the demos given by us and they

will buy that product not because of their increase in income or it becomes a

cheaper product but their neighbour or relatives bought it. Tendency of the

consumer to imitate others will help us to increase the demand for our

commodity.

5. Free goods

More Free goods are given by other producer to attract consumers and that

will affect the demand of our product. So we also gave more free goods than

the other companies.

Because of these reasons we must forced to reduce the price of our

commodity to increase our commodities demand. For this we must know the

different market conditions and the factors affecting demand for a commodity.
DETERMINANTS OF DEMAND

1. Price of a commodity

Price of the commodity is the most important factor that determine demand.

An increase in price of a commodity leads to a reduction in demand and a

decrease in price leads to an increase in demand.

2. Price of related goods

Demand for a commodity depends on Price of related goods also. Related

goods include both substitutes and complementary goods.

Substitutes are those goods which can be used one another or the goods

with same use are substitutes. e.g.:- tea and coffee.

When price of tea falls demand for coffee also falls. Because when price of

tea falls people buy more tea and less coffee.

Complementary goods are those goods which can be used only jointly. e.g.:

- car, petrol or pen, ink. When price of a commodity raises demand for its

complementary goods falls. If x and y are complementary goods we cannot use

x without y. When price of x raises demand for x falls and y cannot be used

without x and demand for y also falls.


3. Income of the consumer

Income of the consumer and demand for a commodity are positively related.

For normal goods when income increases demand also increases and vice

versa. But for inferior goods there is a negative relationship between income

and demand. So when income increases, demand decreases.

Taste and Preferences of consumers

Taste and Preferences of consumers also brings out changes in demand for

a commodity. Tendency to imitate other fashions, advertisements etc affect

demand for a commodity. It change from person to person, place to place and

time to time.

4. Rate of Interest

Higher will be demanded at lower rates of interest and lower will be

demanded at higher rate of interest.

5. Money supply

Demand is positively related to money supply. If the supply of money

increases people will have more purchasing power and hence the demand will

increase and vice versa.

6. Business condition

Trade cycles or business cycles also demand for a commodity. Demand will

be high during boom period and low during depression.


7. Distribution of income

Distribution income in the society also affects the demand of commodity. If

there is equal distribution of income demand for necessary goods and comforts

will be greater. If there is an unequal distribution of income demand of comforts

and luxuries will be greater.

8. Government policy

Government policy also affects the demand of commodities. For example, if

heavy taxes are imposed on certain goods, the demand will decrease. On the

other hand, if government announces tax concessions for certain commodities,

their demand will increase.

9. Consumers’ expectations

Consumers’ expectation about a further rise or fall in future price will affect

the demand of a commodity. If consumers expect a rise in the price of a

commodity in the near future, they may purchase large quantity even though

there is some rise in the price. When the price of a commodity decreases,

people expect a further fall in price and postpone their purchase. Similarly, if

consumers believe that their incomes will rise in the near future they are more

inclined to buy more expensive items today. So these expectations changes the

demand for goods.


CONCLUSION

In the project regarding the elasticity of demand, we discuss different

degrees, types and measurement of elasticity. Applying the theory of elasticity

we have to increase our demand of our commodity. But this increase in demand

will not lead to an increase in cost of production. When cost of production

increases automatically we must sacrifice the rate of profit that we earn. So we

must take some strategic decisions to improve our quality of our commodity and

thereby increase profit, increase in demand and also we have to reduce the

cost of production.

Although most businessmen are very much aware of the elasticity of

demand of the goods they make, the use of precise estimates of elasticity of

demand will add precision to their business decision i.e. the theory of elasticity

of demand is very useful at the time of taking tactical decisions by the top

management. So this project is much useful to us to know how elasticity

influences the working of business and even in our day to day life.

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