Theory of

Demand and Supply

Unit 2
Learning Objectives
On completion of this unit, students will be able to:
 define demand function and explain its types.
 explain about movement along a demand curve and shift in demand curve.
 define supply function and explain its types.
 explain about movement along a supply curve and shift in supply curve.
 explain the degrees of price elasticity of demand and its measurement.
 explain the degrees of income elasticity of demand and its measurement.
 explain the degrees of cross elasticity of demand and its measurement.
 explain the degrees of elasticity of supply and its measurement.
 PART A
Theory of Demand and Supply
Introduction
• The demand and supply are most important factors or forces determining price
and quantity in the free market economy.
• Demand is related with the economic activities of the consumers and supply is
related with the economic activities of the producers or the suppliers.
• These two factors are like two blades of a scissors. It means that as only one
blade of a scissors does not function, likewise one force of the market either
demand or supply also can not function without another.
• The integration of these two forces of the market is necessary to determine the
equilibrium price and quantity of output.
Theory of Demand
Meaning of Demand
• In the ordinary sense, demand and desire are used as a synonymous.
• But, in economics demand implies more than mere desire.
• Demand is the desire backed with willingness and ability to pay.
• The demand for a commodity is also defined as the quantity which consumers are
able and willing to purchase at each possible price during a given period of time,
other things remaining the same.
Essential Elements to be Demand
 Price
 Desire
 Ability
 Willingness
 Time Period
Law of Demand
• The law of demand shows the inverse relationship between the price of a commodity
and its quantity demanded.
• According to this law, the demand for a commodity increases with a fall in its price
and decreases with a rise in its price, other things remaining the same.
Assumptions
 There is no change in income of the consumer.
 There is no change in price of related goods.
 There is no change in tastes and preferences of the consumers.
 There is no change in fashion and habit of the consumer.
 There is no change in climate and season.
 There is no change in size and composition of population.
 There is no expectation of change in the future price of the commodity.
Demand Schedule
A demand schedule is a table that shows prices of a commodity and the quantity
demanded. A hypothetical demand schedule is given in Table.

Price (in Rs.) Quantity Demanded (in Units)

100 1
80 2
60 3
40 4
20 5
Demand Curve
Y
120

• A demand curve is a graph D

a
100
of relationship between the
price of a good and the b
quantity demanded. 80

• A demand curve is c

Price
60
obtained by plotting a
demand schedule into the 40
d
graph.
e
20

D
0 X
0 1 2 3 4 5 6
Quantity
Exceptions to the Law of Demand
1. Expectations regarding future price
2. Prosperity and depression
3. Giffen goods
4. Ignorance
5. Change in fashion, Habit and preference
6. Prestigious goods
Causes of Downward Sloping Demand Curve
1. Income effect
2. Substitution effect
3. Diminishing marginal utility
4. Entry of new consumers
5. Different uses
Determinants of Demand
1. Price of the commodity
2. Income of the consumer
3. Price of the related goods
4. Tastes and preferences of the consumer
5. Advertisement
6. Income distribution
7. Size and composition of population
8. Consumer’s expectation
9. The availability of credit
10. Climate and weather
Demand Function
• In mathematical language, a function is a symbolic statement of relationship between
a dependent and independent variables.
• Demand function states the functional relationship between demand for a commodity
(the dependent variable) and its determinants (the independent variables).
• The determinants of demand are price of the product, price of the related goods,
income of the consumer, size of the population, advertisement, etc.
QX = f(PX, PY, Y, T, P, A, …) … (i)
where
QX = Demand for commodity X PX = Price of commodity X
PY = Price of related goods Y = Income of the consumer
T = Taste of the consumer P = Size of the population
A = Advertisement f = Functional relationship (depend on)
Demand Function Contd.
• The demand function is based on the law of demand.
• The law of demand states the inverse relationship between quantity demanded for
a commodity and its price, other things remaining the same.
QX = f (PX) … (ii)
where
QX = Demand for commodity X
PX = Price of commodity X
Equation (ii) expresses that demand is an inverse function of its price. It means that
when price rises, quantity demanded falls and vice-versa.
Types of Demand Function
1. Linear Demand Function
A demand function is said to be linear when the slope of the demand curve remains
constant throughout its length.
QX = a – bPX … (iii)
where
a = Autonomous demand
b = Slope of the demand curve
If the value of 'a' and 'b' are known, total demand (QX) for any given price (PX) can
be obtained.
Types of Demand Function Contd.
Y
30
Linear Demand Schedule A
Price (in Rs.) Quantity 25

Demanded (in
Units) 20
25 0

Price
20 1 15
15 2
10 3 10
5 4
0 5 5

B
0 X
0 1 2 3 4 5 6
a
Quantity
Types of Demand Function Contd.
Slope of the dema nd curve (b) is the ratio of the cha nge in qua ntity
dema nded to the change in price. Symbolica lly,
 ΔQ
b = – 
 ΔP
where
P = Cha nge in price
Q = Cha nge in qua ntity dema nded
The slope of above dema nd curve ca n be ca lcula ted using formula .
In the dema nd schedule given in ta ble.
Q = 1, P = –5
Q 1
b =– = – –5  = 0.2
P  
Autonomous dema nd (a ) = 5
Hence, dema nd function: Q X = a – bPX
or, Q X = 5 – 0.2PX
Types of Demand Function Contd.
2. Non-linear Demand Function
Y
• A demand function is said to be non- 30
linear when the slope of a demand curve D
25
changes all along the demand curve.
• Non-linear demand function gives a 20
demand curve instead of a demand line.

Price
15
A non-linear demand function takes the
form of a power function as follows: 10
QX = aPX–b ... (iv) D

or of a recta ngula r hyperbola of the form 5

X
a
QX = b 0
PX 0 1 2 3 4 5 6
where a a nd b > 0 Quantity
Movement along a Demand Curve and Shift in
Demand Curve
Movement along a Demand Curve
• Movement along a demand curve is defined as the change in demand for a commodity due to
change in its price, other things remaining the same.
• It is also known as the change in quantity demanded for the commodity.
• When change in demand is caused by change in price, then it is called extension or contraction
in demand or change in quantity demanded.
• The concept of extension and contraction in demand is explained as follows:
Extension in Demand
• Other things remaining the same, when the quantity demanded for a commodity increases due
to fall in its price, it is called extension in demand.
• It is also known as the increase in quantity demanded.
Contraction in Demand
• Other things remaining the same, when the quantity demanded for a commodity decreases due
to rise in price, it is called contraction in demand.
• It is also known as the decrease in quantity demanded.
Movement along a Demand Curve Contd.
Y

P2 Contraction in Demand
C
Price

P
A Extension in Demand
P1
B

D
X
O Q1 Q Q2
Quantity Demanded
Movement along a Demand Curve and Shift in
Demand Curve Cont…
Shift in the Demand Curve (Change in Demand)
• Shift in demand curve is defined as the change in demand for a commodity due to
change in factors other than price of the commodity.
• The other factors include price of related commodities, income of consumer, taste and
preferences of the consumer, habit, fashion, size of the population, etc.
Rightward Shift in the Demand Curve (Increase in Demand)
• Rightward shift in demand curve refers to more demand at the same price of the
commodity due to favourable change in factors other than price of the commodity.
• In this situation, the initial demand curve shifts rightward.
Leftward Shift in the Demand Curve (Decrease in Demand)
• Leftward shift in demand curve refers to less demand at the same price of the
commodity due to unfavourable change in factors other than price of the commodity.
• In this situation, the initial demand curve shifts towards left.
Shift in the Demand Curve (Change in Demand)
Contd.

D2
D
D1

Rightward shift
Price

P
Leftward shift

D2
D1 D
X
O Q1 Q Q2
Quantity Demanded
Difference between Movement along a Demand
Curve and Shift in the Demand Curve
Movement along a Demand Curve
1.It is caused by the change in the price of
the commodity only.
2.It is always along the same demand
curve, i.e. no new demand curve is
drawn.
3.If the quantity demanded for a
commodity increases due to fall in price
of the commodity, it is called extension in
demand. In this case, consumer moves
downward along the same demand
curve.
4.If the quantity demanded for a
commodity decreases with a rise in price
of the commodity, it is called contraction
in demand. In this case, the consumer
moves upwards along the same demand
curve.
Shift in the Demand Curve
1.It is caused by the change in the factors
other than price.
2.It is shown by drawing new demand
curve.
3.If the demand for a commodity rises due
to favourable change in factors other than
price of the commodity, it is called
increase in demand. In this case, demand
curve shifts towards right.
4.If the demand for a commodity falls due
to unfavourable change factors other than
price of the commodity, it is called
decrease in demand. In this case, demand
curve shifts towards left.
Difference between Movement along a Demand
Curve and Shift in the Demand Curve Contd.
Movement along a Demand Curve Shift in the Demand Curve
5. It is also called change in quantity 5. It is also called change in demand.
demanded.
6. The figure of movement along a demand 6. The figure of shift in demand curve is as
curve is as follows: follows:

Y
Y
D D2
D
D1
Price

Price
D D2
D
D1

O X O X
Quantity demanded Quantity demanded
Factors Causing the Shift in the Demand
Curve
1. Change in income of the consumer
2. Change in price of the related goods
3. Change in tastes and preferences of the consumer
4. Change in advertisement expenditure
5. Change in size of population and its composition
6. Change in income distribution
7. Change in the availability of credit
8. Change in expectation
Theory of Supply
Meaning of Supply
• Supply is defined as the quantities of a commodity which its producer or seller is
ready to offer for a sale at a given price and period of time.
• It other words, supply is the quantity of a good or service that a producer or seller
is willing and able to sell at the given price and time period.
Essential Elements to Be supply
 Price
 Quantity
 Willingness and Ability to Sell
 Time Period
Law of Supply
• According to the law of supply, other things remaining the same, the quantity supplied of a
commodity is directly related to the price of the commodity.
• It means that when price rises, the quantity supplied increases, and when price falls, the
quantity supplied decreases.
• Other things mean the price of other commodities, the price of factors of production, the
state of technology and the goals of producers.
Assumptions
 There is no change in price of inputs or factors of production.
 There is no change in state of technology.
 There is no change in goal of producers.
 There is no change in number of producers.
 There is no change in price of other goods.
 There is no change in tax and subsidy policy of the government.
Supply Schedule
A supply schedule is a table that shows various quantities of a commodity offered
for sale at various prices at given period of time. A hypothetical supply schedule is
given in table
Price (in Rs.) Quantity Supplied (Units)
20 5
40 10
60 15
80 20
100 25
Supply Curve Y
120
S
Supply curve is a graph between e
100
the price of a commodity and the
quantity supplied. d
80

Price
60

b
40

a
20
S
0 X
0 5 10 15 20 25 30
Quantity Supplied
Exceptions to the Law of Supply
1. Expected price
2. Change in other factors
3. Agricultural goods
4. Perishable goods
5. Auction sale
Determinants of Supply
1. Price of the commodity
2. Price of the other goods
3. Price of the factors of production
4. Goal of the firm
5. Improvement in technology
6. Government policy
7. Expected future price
8. Number of firms
9. Development of infrastructure
10. Natural factors
Supply Function
Supply function is defined as the functional relationship between supply of a
commodity and its various determinants.
QX = f (PX, PY, Pf, T, G, …) … (i)
where
QX = Supply of commodity X
f = Functional relation (depend on)
PX = Price of commodity X
PY = Price of other goods
Pf = Price of factors of production
G = Goals of the producer
T = State of technology
Supply Function Contd.
Supply function is based on the law of supply. The law of supply states the positive
relationship between the price and the quantity supplied. Other remaining the same,
it may be expressed as
QX = f (PX) … (ii)
where
QX = Quantity supplied of commodity X
PX = Price of commodity X
It means that quantity supplied of a commodity is a function of the price of that
commodity.
Types of Supply Function
1. Linear Supply Function
• If slope of the supply curve remains constant throughout its length, it is called linear
supply functions.
• In other words, if both dependents and independent variables like quantity supplied
and price change at the constant rate, supply function or supply curve will be linear.
QX = a + b PX ... (iii)
where
QX = Quantity supplied of commodity X
a = X intercept or autonomous supply or quantity supplied at zero price
b = Slope of the supply curve
PX = Price of the commodity X
Types of Supply Function Contd.
Y
30
Price (in Rs.) Quantity S
Supplied (in 25

Units) 20
0 1
5 2

Price
15

10 3
10
15 4
20 5 5
25 6 Q
0 X
0 1 2 3 4 5 6 7
a
Quantity
Types of Supply Function Contd.
• In figure, QS represents the linear supply curve or linear supply function. The X–
intercept made by the supply curve is 'a’.
• It means that quantity supplied at zero price or autonomous supply is equal to
OQ, i.e. 1 unit.
• The slope of supply curve (b) is the ratio of change in quantity supplied (Q) and
change in price of the commodity (P).
Q
Slope of the supply curve (b) =
P
In the supply schedule given in ta ble
P = 5, a nd Q = 1
Thus
Q 1
Slope of the supply curve (b) = = = 0.2
P 5
Autonomous supply (a) = 1
Hence, supply function, Q X = a + bPX
or, Q X = 1 + 0.2PX
Types of Supply Function Contd.
2. Non-linear Supply function Y
• If slope of the supply curve changes
along the supply curve, it is called
non-linear supply function. S
• In other words, if both dependent
variable and independent variables

Price
change at different rates, the supply
function is called non-linear supply
function.
S
• It represents non-linear supply curve.
X
QX = aPXb ... (iv) O
Quantity
Movement along a Supply Curve
• Movement along a supply curve is defined as the change in supply of a commodity
to change in its price, other things remaining the same.
• It is also known as the change in quantity supplied of the commodity.
Extension in Supply
• Other things remaining the same, when the more quantities of a commodity are
supplied with the rise in its price, it is called extension in supply.
• It is also known as the increase in quantity supplied.
• In this case, we move upward along the same supply curve.
Contraction in Supply
• Other things remaining the same, when the quantity supplied of a commodity
decreases due to fall in its price, it is called contraction in supply.
• It is also known as the decrease in quantity supplied.
• In this case, we move downward along the same supply curve.
Movement along a Supply Curve Contd.
Y

C
P2
A
Price

P
Extension in Supply
B
P1
Contraction in Supply

X
O Q1 Q Q2
Quantity
Shift in Supply Curve (Change in Supply)
• Shift in supply curve is defined as the change in supply of a commodity due to change
in factors other than price the commodity.
• Other factors include the price of the related goods, state of technology, goal of the
firm, cost of production, government policy, etc.
• A change in any of these factors causes shift in supply curve at the constant price of
the commodity.
• It is also known as change in supply.
• There are two types of shift in supply curve, which are as follows:
Rightward Shift in Supply Curve (Increase in Supply)
When supply of a commodity increases due to favourable change in the factors other
than price of the commodity, it is called increase in supply.
Leftward Shift in Supply Curve (Decrease in Supply)
When supply of a commodity decreases due to unfavourable change in factors other than
its price of the commodity, it is called decrease in supply.
Shift in Supply Curve (Change in Supply)
Contd.
Y

S1
S S2
Leftward shift
Price

P Rightward shift

S1
S
S2
X
O Q1 Q Q2
Quantity
Difference between Movement along a Supply
Curve and Shift in Supply Curve
Movement along a supply curve
1. It is caused by the change in the price of the
commodity only.
2. It is always along the same supply curve, i.e. no
new supply curve is drawn.
3. If the quantity supplied of a commodity increases
due to rise in price of the commodity, it is called
extension in supply. In this case, producer moves
upward along the same supply curve.
4. If the quantity supplied of a commodity decreases
with a fall in price of the commodity, it is called
contraction in supply. In this case, the consumer
moves downwards along the same supply curve.
Shift in supply curve
1. It is caused by the change in the factors other than
price of the commodity. The price of the
commodity remains constant.
2. It is shown by drawing new supply curve.
3. If the supply of a commodity rises due to
favourable change in factors other than price of
the commodity, it is called increase in supply. In
this case, supply curve shifts towards right.
4. If the supply of a commodity falls due to
unfavourable change factors other than price of
the commodity, it is called decrease in supply. In
this case, supply curve shifts towards left.
Difference between Movement along a Supply
Curve and Shift in Supply Curve
Movement along a supply curve Shift in supply curve
5. It is also called change in quantity supplied. 5. It is also called change in supply.
6. The figure of movement along a supply curve is 6. The figure of shift in supply curve is as follows:
as follows:

Y
Y S2

S
S
S1

Price
Price

S2
S
S S1

X
O
X Quantity demanded
O
Quantity demanded
Factors Causing Shift in Supply Curve
1. Change in price of the others goods
2. Change in price of the factors of production
3. Change in goal of the firm
4. Change in technology
5. Change in government policy
6. Change in expectation
7. Change in number of firms
Market Equilibrium
 In the ordinary sense, equilibrium means balance between opposite forces.
 In the context of market analysis, equilibrium refers to a state of market in which
quantity demanded for a commodity equals to the quantity supplied of the
commodity.
 The equality of demand and supply gives an equilibrium price. It means that
equilibrium price is the price at which quantity demanded equals to quantity
supplied.
 Similarly, equilibrium quantity is the quantity demanded and supplied at the
equilibrium price.
Market Equilibrium Contd.
Monthly Demand and Supply Schedules for Potato
Quantity Surplus (+)
Price (Rs./Kg.) Quantity Supplied Pressure on Price
Demanded Shortage (–)
5 50 10 – 40 Upward
10 40 20 – 20 Upward

15 30 30 0 Equilibrium

20 20 40 20 Downward
25 10 50 40 Downward
Market Equilibrium Contd.
Y
30

D S
25 Excess Supply
(Surplus)
20
A B
Price

15 E

D C
10
Excess Demand
5 (Shortage)
S D

0 X
0 5 10 15 20 25 30 35 40 45 50 55 60
Quantity
Change in Market Equilibrium
Y
1. Effect of Shift in
D1
Demand Curve S
• The shift in demand
D
curve causes change in E1
P1
market equilibrium or
change in equilibrium E

Price
P
price and quantity.
D1
• If demand curve shifts
towards right remaining
S
the supply curve constant, D

there will be increase in

X
both equilibrium price O Q Q1
and quantity of output. Quantity
Change in Market Equilibrium Contd.
Y
2. Effect of Shift in Supply
Curve S
• The shift in supply curve D
causes change in market S1
equilibrium or change in E
P
equilibrium price and
quantity.

Price
E1
P1
• If supply curve shifts
rightward given the S D
demand curve constant, the
equilibrium price
S1
decreases but equilibrium
quantity of output X
O
increases. Q Q1
Quantity
Change in Market Equilibrium Contd.
Y
3. Effect of Shift in Both
Demand and Supply
Curves (Simultaneous Shift D1 S
in Demand and Supply
D S1
Curve)
• The effect of simultaneous E E1

Price
P
shift in demand and supply
curves depend upon the
extent of shift in them. S D1
• If relative shift in demand S1 D
and supply curves are equal
and parallel, equilibrium price X
will remain same but quantity O Q Q1
of output will change. Quantity
 PART B
Elasticity of Demand and
Supply
Introduction
 The law of demand only shows the direction of change in demand for a
commodity due to change in its price. This law does not explain the degree of
relationship between the change in price of the commodity and its quantity
demanded.
 The explanation on how much or to what extent quantity demanded for a
commodity changes as a result of change in price, we study in the elasticity of
demand.
 Similarly, law of supply states only the positive relationship between price of a
commodity and its quantity supplied. The answer of this question is given by the
elasticity of supply.
Elasticity of Demand and Types
Meaning/ Definition of Elasticity of Demand
The elasticity of demand is the measure of responsiveness of demand for a
commodity to the change in any of its determinants, such as price of the same
commodity, price of the related commodities, consumer’s income, tastes and
preferences of the consumer, consumer’s expectations regarding prices, etc.
Types of Elasticity of Demand
1. Price elasticity of demand
2. Income elasticity of demand
3. Cross elasticity of demand
Price Elasticity of Demand (EP)
• Price elasticity of demand is defined as the responsiveness of change in quantity
demanded of a commodity to the change in its price.
• In other words, the price elasticity of demand is defined as the ratio of percentage
change in quantity demanded to the percentage change in price.

Percentage change in quantity demanded

EP = Percentage change in price
Change in quantity demanded Q
Initial Quantity demanded × 100 Q × 100 Q P
= Change in price = = .
P P Q
Initial Price × 100 P × 100
Types (Degrees) of Price Elasticity of
Demand
Y
1. Perfectly Elastic Demand
(EP = )
• Demand is said to be
perfectly elastic if EP = ∞
negligible change in price

Price
P1 D
leads to infinite change in
the quantity demanded.
• Perfectly elastic demand is
theoretical concept.
X
O
• It is hardly found in Q1 Q2 Q3

practice or real life. Quantity Demanded

Types (Degrees) of Price Elasticity of Demand
Contd.
Y
2. Perfectly Inelastic
Demand (EP = 0) D

• When the demand for a

commodity does not P3
change with the change in
its price, the demand is

Price

EP = 0
P2
said to be perfectly
inelastic.
P1
• For example, medicine and
salt have perfectly inelastic
demand. X
O Q1
Quantity Demanded
Types (Degrees) of Price Elasticity of Demand
Contd.
3. Unitary Elastic Demand Y

(EP = 1)
D
• When the percentage change
in the quantity demanded is
equal to the percentage P1
EP = 1
change in price, the demand 20%

Price
for a commodity is said to be P2
unitary elastic demand. D
• For example, if a 20%
20%
change in price causes 20%
change in demand, it is the
case of unitary elastic X
O Q1 Q2
demand.
Quantity Demanded
Types (Degrees) of Price Elasticity of Demand
Contd.
Y
4. Relatively Elastic Demand
(EP > 1)
• When the percentage change D
in the quantity demanded for
P1
a commodity is more than EP > 1
percentage change in its

Price
20%
price, it is called relatively P2
elastic demand. D
• Such kind of elasticity of 30%
demand is found in case of
luxury goods like LED X
television, refrigerator, car, O
Q1 Q2
etc. Quantity Demanded
Types (Degrees) of Price Elasticity of Demand
Contd.
Y
5. Relatively Inelastic
Demand (EP < 1)
D
• If the percentage change in
P1
the quantity demanded for
a commodity is less than EP < 1
the percentage change in 20%

Price
its price, it is called
relatively inelastic P2
demand. D

• It is found in case of 10%

necessity or basic good

like rice, vegetable, O Q1 Q2
X

clothes, etc. Quantity Demanded

Methods of Measuring Price Elasticity of Demand
1. Percentage Method
• Percentage method was developed by Prof. Flux as an improvement over the outlay
method. The price elasticity of demand is measured by its coefficient.
• The coefficient (EP) measures the percentage change in the quantity demanded of a
commodity resulting from a given percentage change in its price.
• According to this method, EP is calculated by using following formula:
Percentage change in quantity demanded
EP = Percentage change in price
∆Q ∆Q
Q × 100 Q
  Q P
= ∆P = ∆P = ×
  P Q
P × 100 P
 
If EP > 1, demand is elastic. If EP < 1, demand is inelastic. If EP = 1, demand is unitary
elastic.
Methods of Measuring Price Elasticity of Demand
Contd.
2. Point Method (Geometric Method)
• Point method is also an important method of measuring price elasticity of
demand. It is also known as the geometric method or graphical method.
• This method was developed by Alfred Marshall for measuring price elasticity of
demand at a point on a demand curve.
• Therefore, this method is the measure of price elasticity of demand at a particular
point of demand curve.
• This method is used when very small change in price of the commodity results in
very small change in its quantity demanded.
• In this case, the price elasticity formula can be expressed as
Q P
EP = ×Q
P
Methods of Measuring Price Elasticity of Demand
Contd.
i. Point Elasticity on a Linear Y
Demand Curve
By using the above formula of A(EP = )
the price elasticity of demand
geometrically we can derive the D(EP > 1)

Price
following formula to measure
the price elasticity of demand on C(EP = 1)
a straight line demand curve or
linear demand curve.
E(EP < 1)
Lower segment of the demand curve
EP = Upper segment of the demand curve B(EP = 0)
X
O
Quantity Demanded
Methods of Measuring Price Elasticity of Demand
Contd.
• The downward sloping curve AB represents linear demand curve. Let us suppose,
C as the middle point of the demand curve AB.
• Using the formula of the point elasticity of demand, we can find out coefficient
of price elasticity of demand at different points of the demand curve by using
point method as follows:
Lower segment of the demand curve CB
EP at the point C = Upper segment of the demand curve = AC = 1 (∵ CB = AC)

Hence, at the point C, demand is unitary elastic.

Lower segment of the demand curve AB
EP at the point A = Upper segment of the demand curve = 0 = 
Hence, at the point A, demand is perfectly elastic.
Lower segment of the demand curve DB
EP at the point D = Upper segment of the demand curve = AD > 1 (∵ DB > AD)

Hence, at the point D, demand is relatively elastic.

Methods of Measuring Price Elasticity of Demand
Contd.
Lower segment of the dema nd curve EB
EP a t the point E = Upper segment of the dema nd curve = AE < 1 (∵ EB < AE)

Hence, a t the point E, dema nd is rela tively inela stic.

Lower segment of the dema nd curve 0
EP a t the point B = Upper segment of the dema nd curve = AB = 0
Hence, a t the point B, dema nd is perfectly inela stic.
Methods of Measuring Price Elasticity of Demand
Contd.
ii. Point Elasticity on a Non- Y

linear Demand Curve

• Point elasticity on a non-liner
A
demand curve is measured by D
drawing a tangent to the
demand curve at the chosen
point and measuring the
elasticity of the tangent line at R

Price
P
this point.
• The price elasticity of demand D

at point R is as
Lower segment of the tangent line RB X
EP = Upper segment of the tangent line = AR O Q B
Quantity
Methods of Measuring Price Elasticity of Demand
Contd.
3. Total Outlay Method
• According to this method, we compare total outlay of a consumer before and after
the variations in price.
• Total outlay is the price multiplied by the quantity of a good purchased.
Total outlay (Total expenditure) = Price × Quantity purchased
i. Elasticity greater than unity (EP > 1): When total expenditure increases with the
fall in price and decreases with the rise in price, the demand is said to be elastic
demand.
ii. Elasticity less than unity (EP < 1): If with the fall in price, the total expenditure
decreases and with the rise in price, the total expenditure increases, demand is said
to be less than unity.
iii. Elasticity equal to unity (EP = 1): When the total expenditure remains unchanged
with a fall or rise in price, the price elasticity of demand is said to be equal to unity.
Methods of Measuring Price Elasticity of Demand
Contd.
Total
Price (P) Quantity (Q) Expenditure
Situation EP
(in Rs.) (in unit)
TE = P  Q
6 1 6
I EP > 1
5 2 10
4 3 12
II EP = 1
3 4 12
III 2 5 10 EP < 1
Methods of Measuring Price Elasticity of
Demand Contd.
Y
7
T
6 EP > 1
A

5
B

4
Pric e

C
EP = 1
3 D

E
2

F
1 EP < 1
G
0 X
0 2 4 6 8 10 12 14 16
Total Expenditure
Methods of Measuring Price Elasticity of
Demand Contd.
4. Arc Elasticity of Demand Y
• The coefficient of price
elasticity of demand D

between two points on a P1 A

demand curve is called arc
elasticity of demand. C

Price
• This method is used when
there is large change in P2 B
price and quantity D
demanded.
• Any two points on a
demand curve make an arc O
X
Q1 Q2
as in figure.
Quantity
Methods of Measuring Price Elasticity of
Demand Contd.
The formula for mea suring price ela sticity of dema nd at the middle point C of the a rc
on the dema nd curve is:
Q
Change in quantity demanded Q1 + Q2
 Average quantity demanded  2
 
EP = =
Change in Price  P
 Average Price 
  P1 + P2
2
Q P1 + P2 Q2 - Q1 P1 + P2
= × = ×
P Q1 + Q2  P2 - P1  Q1 + Q2
where
Q 1 = Initia l qua ntity dema nded Q2 = New qua ntity dema nded
P1 = Initia l Price P2 = New Price
ΔQ = Cha nge in qua ntity dema nded ΔP = Cha nge in Price
Uses or Importance of Price Elasticity of
Demand
1. Monopoly price determination
2. Price determination under discriminating monopoly
3. Price determination of public utilities
4. Price determination of joint products
5. Wage determination
6. International trade
7. Importance to finance minister
Income Elasticity of Demand (EY)
• Income elasticity of demand is defined as the degree of responsiveness of
demand for a commodity to the change in the income of the consumer.
• In other words, income elasticity of demand is the ratio of the percentage change
in demand for a commodity to the percentage change in income.
Percentage change in quantity demanded
EY = Percentage change in income
Change in quantity demanded Q
Initial quantity demanded × 100 Q × 100 Q Y
= Change in income = = ×
Y Y Q
Initial income × 100 Y × 100
where
EY = Coefficient of income ela sticity of dema nd
Q = Initia l qua ntity dema nded ∆Q = Cha nge in qua ntity dema nded
Y = Initia l income ∆Y = Cha nge in income
Types of Income Elasticity of Demand
1. Positive Income Elasticity of Demand (EY > 0)
• If increase in income leads to increase in demand for a commodity and decrease in
income leads to decrease in demand for a commodity, it is called positive income
elasticity of demand.
• The commodity, which has positive income elasticity is called normal good.
• Positive income elasticity can be divided into three types:
a. Income elasticity greater than unity (EY > 1):
b. Income elasticity greater than unity (EY > 1):
c. Income elasticity equal to unity (EY = 1):
Types of Income Elasticity of Demand Contd.
a. Income elasticity greater than Y

unity (EY > 1): The income

elasticity of demand is greater
than unity when the demand for EY > 1 D
Y2
a commodity increases more

Income
5%
than percentage to rise in Y1

income. D
10 %

X
O Q1 Q2
Quantity Demanded
Types of Income Elasticity of Demand Contd.
b. Income elasticity greater than Y

unity (EY > 1): Income elasticity

of demand is less than unity
D
when the demand for a EY < 1
commodity increases less than Y2

percentage rise in income. 10 %

Income
Y1

D
5%

X
O Q1 Q2
Quantity Demanded
Types of Income Elasticity of Demand Contd.
c. Income elasticity equal to Y
unity (EY = 1): Income elasticity
is unity when the demand for a D
commodity increases in the same EY = 1
proportion as the rise in income. Y2

Income
5%
Y1

D 5%

X
O Q1 Q2
Quantity Demanded
Types of Income Elasticity of Demand Contd.
Y
2. Zero Income Elasticity of
Demand (EY = 0) D
• If quantity demanded remains
unchanged despite change in Y3
income and vice-versa, the
income elasticity is said to be

Income
Y2 EY = 0
zero.
• It is found in case of neutral Y1
goods like salt.
X
O Q1
Quantity Demanded
Types of Income Elasticity of Demand Contd.
3. Negative Income Elasticity of Y

Demand (EY < 0)

• When the consumer reduces his D

demand with the rise in income Y2 EY < 0

and vice versa, the income

Income
10%
elasticity of demand is said to be Y1
negative.
• It is found in case of inferior or D
5%
low quality goods.
X
O Q2 Q1

Quantity
Measurement of Income Elasticity of
Demand
1. Percentage Method
According to the percentage method, income elasticity of demand is measured
dividing percentage change in demand by percentage change in income.
Percentage change in demand
EY = Percentage change in income

Q
Q × 100 Q Y
= = ×
Y Y Q
Y × 100
where
EY = Income elasticity
Q = Initia l qua ntity ∆Q = Cha nge in qua ntity
Y = Initia l income ∆Y = Cha nge in income
Measurement of Income Elasticity of Demand
Contd.
Y
2. Arc Method
• The coefficient of income elasticity of D
demand between two points on an
income demand curve is called arc Y2
B

elasticity of income demand.

Income
• This method is used when there is big Y1
A

change in income and demand. D

• According to this method, income

elasticity of the demand is the X
coefficient of average between two O Q1 Q2
points of income- demand curve. Quantity
Measurement of Income Elasticity of Demand
Contd.
Arc ela sticity between point A a nd B income dema nd curve DD (EY),
Q
Change in demand Q1 + Q2
 Average demand  2
 
EY = Change in Income =
  Y
 Average Income 
  Y1 + Y2
2
Q  Y1 + Y2  Q2 – Q1  Y1 + Y2 
= × Q + Q  =  Y – Y  Q + Q 
Y  1 2  2 1  1 2
where
EY = Coefficient of income ela sticity of dema nd
Q 1 = Initia l qua ntity dema nded Y1 = Initia l income of the consumer
Q 2 = New qua ntity dema nded Y2 = New income of the consumer
Q = Cha nge in qua ntity dema nded Y = Cha nge in income
Measurement of Income Elasticity of Demand
Contd.
3. Point Method
• Income demand curve slopes upward in case of normal goods. But it slopes
downward in case of inferior goods.
• Here, we will measure income elasticity at a point of income demand curve,
which slopes upward from left to right.
• Income demand curve may be linear or non-linear.
• We measure point elasticity in both linear and non-linear income demand curve.
i. Point Elasticity on a Linear Income Demand Curve
• Income elasticity of demand is the ratio of percentage change in demand and
percentage change in income.
• Therefore, income elasticity of demand at a point is given as
Measurement of Income Elasticity of Demand
Contd.
Q Y
EY = ×
Y Q
where
EY = Coefficient of income ela sticity of dema nd
Q = Cha nge in demand  Y = Cha nge in income
Q = Initia l demand Y = Initia l income

• In figure, DD curve represents linear income demand curve.

• Let us suppose, we have to measure income elasticity of demand at point A of the
linear income demand curve DD.
Measurement of Income Elasticity of Demand
Contd.
Y

D
B
Y2
A

Income
Y1 C

X' X
E O Q1 Q2

Quantity
Measurement of Income Elasticity of Demand
Contd.
InFigure,
Initial income (Y1 ) = Q1 A New income (Y2 ) = Q2B
Change in Income (DY) = CB New demand (Q1 ) = OQ2
Initial demand (Q) = OQ1 Change in demand ( D Q) = Q1 Q2
Putting these values in equation (i),
Q1 Q2 AQ1
EY = BC × OQ ... (ii)
1

Since the triangles, ABC and D EQA are similar,

AC EQ1
BC = AQ1 ... (iii)
Again, in the figure,
Q1 Q2 = AC ... (iv)
Measurement of Income Elasticity of Demand
Contd.
Putting AC = QQ 1 , in equa tion (iii)
Q1Q2 EQ1
BC = AQ1 ... (v)
Q 1Q 2 EQ 1
Putting BC = AQ in equa tion (ii), we get,
1
EQ1 AQ1
EY at point A = AQ × OQ
1 1
EQ1
 EY at point A = OQ
1

Since EQ 1 > OQ 2 , income ela sticity a t point A is rela tively elastic or grea ter tha n
one. Hence, it ca n be conclude tha t:
a . If income dema nd curve cuts Y–a xis or it meets X– a xis left of origin, EY > 1.
b. If income dema nd curve pa sses through the origin, income ela sticity of dema nd
will be unita ry or EY = 1. It ha s been shown in the following figure.
Measurement of Income Elasticity of Demand
Contd.
Y

Income
X
O Q1

Quantity
OQ 1
EY at point A = OQ = 1 (... OQ 1 = OQ 1 )
1
Measurement of Income Elasticity of Demand
Contd.
Y
c. If income demand curve meets X–
axis at any point right of the origin,
income elasticity of demand will be D
relatively inelastic. It is shown in
A
figure.

Income
BQ 1
EY a t point A = OQ < 1 (∵ BQ 1 < OQ 1 )
1

X
O B Q1

Quantity
Measurement of Income Elasticity of Demand
Contd.
Y

ii. Income Elasticity of P

Demand at a Point D
K
on a Non–linear C
Income Demand
N
Curve

Income
If demand curve is non-
B
linear, than the income
elasticity of demand at a
A
point can be computed by D

drawing tangent line to

that point and apply the
same formula that is used X'
M O Q1 L Q2 Q3
X

in case of linear demand Quantity

curve. Y'
Measurement of Income Elasticity of Demand
Contd.
• In figure, DD is the non-linear income demand curve. There are three points A, B and C
along the demand curve DD.
• The straight line MN is tangent at point A; the straight line OK is tangent at point B and
the straight line LP is tangent at point C.
Hence, OQ 2
EY at B = OQ = 1 (... OQ 2 = OQ 2 )
2

MQ 1
EY at A = OQ > 1 (... MQ 1 > OQ 1 )
1

LQ 3
EY at C = OQ < 1 (... LQ 3 < OQ 3 )
3

• It also shows that at the different point of a non-linear income-demand curve, there are
different degrees of income elasticity of demand.
Uses or Importance of Income Elasticity of Demand

1. Useful to know about stage of trade cycle

2. Useful for forecasting demand
3. Useful for classification of normal and inferior goods
4. Useful for making marketing strategy
Cross Elasticity of Demand (EXY)
• The cross elasticity of demand is defined as the percentage change in the quantity
demanded of good X resulting from a percentage change in the price of good Y.
• In other words, the ratio of percentage change in the quantity demanded for good X to a
given percentage changes in the price of good Y.
Percentage change in demand for good X
EXY = Percentage change in price of good Y

Change in demand for good X QX

Initial demand for good X × 100 QX × 100 QX PY
= Change in price of good Y = = ×
PY PY QX
× 100
Initial price of good Y PY × 100
where
EXY = Coefficient of cross ela sticity of dema nd
PY = Price of good Y ∆PY = Cha nge in the price of good Y
Q X = Qua ntity of good X ∆Q X = Cha nge in the dema nd for good X
Types of Cross Elasticity of Demand
1. Positive Cross Elasticity Y
of Demand (EXY > 0)
• When the demand for a D
commodity and price of the P2

Price of Tea
related commodity change
into the same direction, the
cross elasticity of demand EXY > 0
P1
is positive.
D
• In the case of substitute
goods, the cross elasticity
of demand is positive. O Q1 Q2
X

Quantity of Coffee
Types of Cross Elasticity of Demand
Y
2. Negative Cross Elasticity
of Demand (EXY < 0) D
• When demand for a P1
commodity and price of

Price of Car
related commodity change EXY < 0
into opposite direction, the
cross elasticity of demand is P2
negative.
D
• In the case of complementary
goods, cross elasticity of
demand is negative. X
O Q1 Q2

Quantity of Petrol
Types of Cross Elasticity of Demand
Y
3. Zero Cross Elasticity of
Demand (EXY = 0)
D
• When the change in price of
one good has no effect on the
demand for another good, the P2

Price of Car
cross elasticity of demand is EXY = 0
zero.
P1
• For example, price of car and
demand for rice have zero
cross elasticity of demand.
X
O Q1
Demand for Rice
Measurement of Cross Elasticity of Demand
1. Percentage Method
According to percentage method, cross elasticity of demand is measured dividing
percentage change in demand for a good X divided by percentage change in price of good
Y.
Percentage change in demand for good X
EXY = Percentage change in price of good Y
QX
QX × 100 QX PY
= = × Q
PY PY X
PY × 100
where
EY = Cross ela sticity of dema nd between good X a nd good Y
Q X = Initia l qua ntity of good X ∆Q X = Cha nge in dema nd for good X
PY = Initia l price of good Y ∆PY = Cha nge in price of good Y

If EXY > 0 , the good X and good Y are substitute goods; if E XY < 0, the good X and good Y
are complementary goods and if EXY = 0, the good X and good Y are non-related goods.
Measurement of Cross Elasticity of Demand Contd.
2. Arc Method
Y
• The coefficient of cross elasticity
of demand between two points on D
a cross demand curve is called arc
elasticity of demand. B

Price of Good Y
PY2
• This method is used to measure the
cross elasticity of demand when A
PY1
there is greater change in price and
quantity demanded. D

• According to this method, cross

elasticity of demand is the O
X
QX1 QX2
coefficient or average between two
Demand for Good X
points along a cross demand curve.
Measurement of Cross Elasticity of Demand Contd.
In figure, DD represents cross demand curve of substitute goods X and Y.
The cross elasticity between two points A and B is measured by using following
formula:
Q
Change in demand for Good X QX1 + QX2
 Average demand for Good X  2
 
EXY = =
Change in Price of Good Y PY
 Average Price of Good Y 
  PY1 + PY2
2
QX  PY1 + PY2  QX2 – QX1  PY1 + PY2 
= ×  =  × 
PY QX1 + QX2  PY2 – PY1  QX1 + QX2
where
EXY = Coefficient of cross ela sticity of dema nd
Q X1 = Initia l demand for good X Q X2 = New dema nd for good X
PY1 = Initia l price of good Y PY2 = New price of good Y
Measurement of Cross Elasticity of Demand Contd.
If good X and good Y are complementary goods, the cross demand curve will slope
downward but method of measuring cross elasticity of demand by arc method will
be same.
If EXY > 0 , the good X and good Y are substitute goods; if EXY < 0, the good X and
good Y are complementary goods and if EXY = 0, the good X and good Y are non-
related goods.
Uses or Importance of Cross Elasticity of Demand
1. Classification of goods
2. Classification of market
3. Pricing policy
4. Determination of boundaries between industries
Determinants of Elasticity of Demand
1. Nature of the commodity
2. Substitute
3. Goods having several uses
4. Joint demand
5. Income of the consumer
6. Postpone of the consumption
7. Habits
8. Price level
9. Time factor
Elasticity of Supply
The elasticity of supply is defined as the ratio between percentage change in
quantity supplied and percentage change in price of a commodity.

Percentage change in quantity supplied

Es = Percentage change in price
Change in quantity supplied ∆Q
Initial quantity supplied × 100 Q × 100 ∆Q P
= Change in price = ∆P = ∆P × Q
Initial price × 100 P ×100
where
ES = Coefficient of ela sticity of supply
P = Initia l price ∆P = Cha nge in price
Q = Initia l qua ntity supplied ∆Q = Cha nge in qua ntity supplied
Types (Degrees) Price of Elasticity of Supply
1. Perfectly Elastic Supply Y

(ES = )
• Supply is said to be
perfectly elastic supply if
ES = ∞
negligible change in price

Price
P1 S
leads to infinite change in
the quantity supplied.
• Visibly, no change in price
causes infinite change in X
supply. It is shown in O Q1 Q2 Q3
figure. Quantity Supplied
Types (Degrees) Price of Elasticity of Supply Contd.
Y
2. Perfectly Inelastic
Supply (ES = 0)
When the supply of a S
commodity does not change
P2
despite the change price, the

Price
supply is said to perfectly 20%
inelastic supply. ES = 1
P1

20%
S
X
O Q1 Q2

Quantity
Types (Degrees) Price of Elasticity of Supply Contd.
3. Unitary Elastic Supply Y
(ES = 1)
S
When the percentage change
in the quantity supplied is
equal to the percentage P3
change in price, the supply of
a commodity is said to be

Price
P2
unitary elastic. ES = 0

P1

O X
Q1

Quantity Supplied
Types (Degrees) Price of Elasticity of Supply Contd.
Y
4. Relatively Elastic
Supply (ES > 1)
• When the percentage S
change in the quantity P2
supplied of a commodity is

Price
more than the percentage 20%
change in price, it is called P1 ES > 1
relatively elastic supply.
S
• It is also called elasticity 30%

greater than unity.

O X
Q1 Q2
Quantity
Types (Degrees) Price of Elasticity of Supply Contd.

5. Relatively Inelastic Y
Supply (ES < 1)
• When the percentage S
change in the quantity P2
supplied of a commodity is
less than percentage 20%

Price
change in price, it is called
ES < 1
relatively inelastic supply. P1
• It is also called elasticity
S 15%
less than unity.
O X
Q1 Q2
Quantity
Measurement of Elasticity of Supply
1. Percentage Method
According to this method, elasticity of supply is calculated dividing percentage
change in quantity supplied divided by percentage change in price.
Percentage change in quantity supplied
ES = Percentage change in price
Change in quantity supplied  Q
 Initial quantity supplied × 100  Q × 100
  Q P
= = = ×
Change in Price  P P Q
 Initial Price × 100 
  P × 100
where
ES = Coefficient of ela sticity of supply
Q = Initia l qua ntity supplied P = Initia l Price
Q = Cha nge in quantity supplied P = Cha nge in price
 Measurement of Elasticity of Supply Contd.
2. Arc Method Y

• The coefficient of elasticity of supply

between two points on a supply curve is S
called arc elasticity of supply.
B
• This method is used to measure elasticity P2
of supply when there is greater change in

Price
price and quantity supplied. A
P1
• According to this method, elasticity of S
supply is the coefficient of average
between two points along a supply curve.
• Figure shows the measurement of X
O Q1 Q2
elasticity of supply between two points A
and B along the supply curve SS. Quantity
Measurement of Elasticity of Supply Contd.
 Q 
Q1 + Q2
Change in quantity supplied  
 Average quantity supplied 
   2 
ES = =
Change in Price   P 
 Average Price  P1 + P2
 
 
 2 
Q  P1 + P2  Q2 – Q1  P1 + P2 
= × Q + Q  =  P – P  Q + Q 
P  1 2  2 1  1 2

where
ES = Coefficient of ela sticity of supply
Q 1 = Initia l qua ntity supplied Q 2 = New qua ntity supplied
P1 = Initia l price P2 = New price
Measurement of Elasticity of Supply Contd.
3. Point Method
• Point method is used to measure price elasticity of supply when there is very
small change in price and quantity supplied.
• It is the measure of the percentage change in quantity supplied in response to a
very small percentage change in price.
• To calculate the elasticity of supply at any point of a supply curve, the following
formula is used:
Q P
ES = ×
P Q
where
ES = Coefficient of elasticity of supply
P = Initia l price ∆P = Change in price
Q = Initia l qua ntity supplied ∆Q = Change in quantity supplied
The elasticity of supply depends upon the na ture a nd slope of the supply curve.
Therefore, the mea surement of ela sticity of supply is varied a s follows:
Measurement of Elasticity of Supply Contd.
i. Point Elasticity on a Linear Y
Supply Curve
• In figure, supply curve SS S
represents the linear supply curve C
P1
and P is the point where elasticity

Price
B
of supply is to be measured. P N

• It shows that initial quantity

supplied OQ at initial price QP. S
When price increases to P1Q1,
quantity supplied increases to OQ1.
X'
• The supply curve SS meets at point A O Q Q1
X

A on the X-axis left from the Quantity

origin.
Measurement of Elasticity of Supply Contd.
Let,
Initial price (B) = OP = QB New Price = OP1 = Q 1C
Initial Quantity Supplied (Q) = OQ New Quantity Supplied = OQ 1
Change in price (P) = PP1 = NC Change in quantity supplied (Q) = QQ 1
Q P QQ1 QB
ES at point B = × Q = NC × OQ … (i)
P
Since  BNC a nd  AQB a re simila r triangles,
BN AQ
NC = QB … (ii)
Aga in in the figure,
BN = QQ1 … (iii)
Putting BN = QQ 1 in equa tion (ii), we get,
QQ1 AQ
NC = QB … (iv)
Measurement of Elasticity of Supply Contd.
QQ 1 QB
Putting NC = OQ in equation (i), we get,
AQ QB AQ
ES at point B = QB × OQ = OQ … (v)
The above equation (v), clearly shows that at point B, price elasticity of supply is
calculated dividing AQ by OQ. Hence, at point B, E S is gre ater than one or relatively
elastic. Hence, it can be concluded that
a. If supply curve meets X – axis left of origin, price elasticity of supply will be
relatively elastic.
AQ
ES at point B = OQ > 1 ( ∵ AQ > OQ)

b. If linear supply curve passes through origin, price elasticity of supply will be
unitary elastic or ES = 1.
Measurement of Elasticity of Supply Contd.
In figure, the supply curve OS is Y

passing through the origin. The

supply elasticity at point A is the ratio S
between OQ and OQ. Therefore, the
supply elasticity at point A is unitary A

Price
P
elastic.
ES = 1
OQ
ES at point A = OQ = 1 (... OQ = OQ)

O X
Q
Quantity
Measurement of Elasticity of Supply Contd.
Y
c. If supply curve does not meet Y­–
axis or it meets X–axis rightward
from the origin, price elasticity of
S
supply will be relatively inelastic,
i.e. ES < 1. B

Price
P
In figure, at point B, AQ is less than
OQ. Therefore, the supply elasticity at
point B is inelastic or less than unity. ES < 1
The supply elasticity at point B is the
ratio between AQ & OQ, which is
less than unity.
O X
A Q
AQ
ES at point B = OQ < 1 (∵ AQ < OQ) Quantity
Measurement of Elasticity of Supply Contd.
Y
ii. Point Elasticity on a Non-linear
Supply Curve S
C
D
When the supply curve is a real curve,
the supply elasticity is measured by E1

drawing a line tangent to the supply F

curve. When the tangent line cuts

Price
quantity axis, the supply elasticity will E2
be inelastic; when the tangent line cuts
price axis the supply elasticity will be E3
S
elastic and when tangent line passes
through origin the supply elasticity will
be unitary elastic. The measurement of
X' X
supply elasticity on non- linear supply a O Q1 B Q2 Q3
curve can be shown in Figure. Quantity

Y'
Measurement of Elasticity of Supply Contd.
In figure, SS is a non-linea r supply curve. To measure ela sticity a t point E1 , E2 a nd E3 ,
three tangents BC, OD and AF a re dra wn a long the supply curve. The coefficients of
price elasticity at different points a re as follows:
a. The ela sticity at point E2 is unity
OQ 2
i.e., Es = OQ = 1 (... OQ 2 = OQ 2 .)
2
b. Simila rly, the ela sticity a t point E1 is less tha n unity
BQ 3
i.e., Es = OQ < 1 (... OQ 3 > BQ 3)
3
c. At point E3 the supply ela sticity is grea ter tha n unity
AQ 1
i.e., ES = OQ > 1 (... AQ 1 > OQ 1 )
1
Factors Influencing Elasticity of Supply
1. Nature of the commodity
2. Cost of production
3. Time element
4. Producers expectation
5. Technical condition of production
Numerical Examples 1
Derive demand function from the following demand schedule:
PX 40 30 20 10 0
QX 0 100 200 300 400

SOLUTION
According to question
Autonomous dema nd (a ) = 400
Q 100
Slope of dema nd curve (b) = – = – –10  = 10
P  
We know tha t
Dema nd function: Q X = a – bPX
or, Q X = 400 – 10PX
Numerical Examples 2
Let, autonomous demand is 10 and slope of the demand curve is 2. Derive the linear
demand function.
SOLUTION
Given
Autonomous demand (a) = 10
Slope of the demand curve (b) = 2
We know that
Supply function, QX = a – bPX
or, QX = 10 – 2PX
Numerical Examples 3
Suppose the demand function Qd = 1000–20P and supply function Qs = 100 +40P
a. Fill up the table given below.
Price (in Rs.) Quantity Demanded (Qd) Quantity Supplied (Qs)
5    
10    
15    
20    
25    

b. Find equilibrium price and quantity algebraically.

c. Show Qd, Qs and prices in the graph.
SOLUTION
a. Given
Demand function, (Qd) = 1000 – 20P
Supply function, (Qs) =100 + 40P.
Thus,

Quantity demanded Quantity supplied

Price (in Rs.) (Qd) = 1000 – 20P (Qs) = 100 + 40P
5 1000 – 20 × 5 = 900 100 + 40 × 5 = 300
10 1000 – 20 × 10 = 800 100 + 40 × 10 = 500
15 1000 – 20 × 15 = 700 100 + 40 × 15 = 700
20 1000 – 20 × 20 = 600 100 + 40 × 20 = 900
25 1000 – 20 × 25 = 500 100 + 40 × 25 = 1100
b. Given
Qd = 1000 – 20P and Qs = 100 + 40P
For market equilibrium, Qd = Qs
or 1000 – 20P = 100 + 40P
or 60P = 900
or P = 15
Thus, equilibrium price = Rs. 15
Putting the value of P in demand and supply function, we get
Qd = 1000 – 20 × 15 = 700
Qs = 100 + 40 × 15 = 700
Thus, equilibrium quantity = 700 units
c. Diagrammatic representation of Qd, Qs and price.

Y
30

D S
25

20
Price (Rs.)

E
15

10

5
S D
0 X
0 100 200 300 400 500 600 700 800 900 1000 1100 120 0
Quantity Demanded
Numerical Examples 4
The demand function for a commodity is Q = 100 – 5P. Find out point elasticity at
price Rs. 10.
SOLUTION
Here,
Initial price = Rs. 10
Initial quantity demanded (Q) = 100 – 5P
= 100 – 5 × 10 = 50
We know tha t
dQ d(100 – 5P)
dP = dP = -5
dQ P 10
Point Ela sticity (EP) = dP × Q = –5 × 50 = – 1
Since EP = – 1, it is the ca se of unita ry price ela sticity of dema nd.
Numerical Examples 5
Calculate the price elasticity of demand by proportionate and arc method when price
decreases from Rs. 20 to Rs. 10 in the following example:
Price (Rs.) 20 10
Demand 40 80

SOLUTION
Proportionate Method
Initia l price (P) = Rs. 20 Initia l qua ntity (Q) = 40
New price (P1 ) = Rs. 10 New qua ntity (Q 1 ) = 80
P = –10 Q = 40
Q P 40 20
EP = × Q = –10 × 40 = – 2
P
Since EP = – 2, the dema nd is rela tively ela stic.
Arc Method/ Mid Point Method/ Average Method
Q2 – Q1 P1 + P2 80 – 40 20 + 10
EP = P – P × Q + Q = 10 – 20 × 40 + 80 = – 1
2 1 1 2

Since EP = – 1, the dema nd is unita ry price ela stic.

Numerical Examples 6
Suppose a following demand schedule:
Price (Rs.) 100 80 60 40 20 0
Demand 100 200 300 400 500 600
a. Find the elasticity for the fall in price from the Rs. 80 to Rs. 60.
b. Calculate the elasticity for the increase in price from Rs. 60 to Rs. 80.
SOLUTION
a. Here
Initia l price (P) = Rs. 80 Initia l qua ntity (Q) = 200 units
New price (P1 ) = Rs. 60 New qua ntity (Q 1 ) = 300 units
∆P = P1 – P = 60 – 80 = – Rs. 20 ∆Q = Q 1 – Q = 300 – 200 = 100 units
We know tha t
∆Q P 100 80
EP = ∆P × Q = – 20 × 200 = – 2
b. Here
Initia l price (P) = Rs. 60 Initia l qua ntity (Q) = 300 units
New price (P1 ) = Rs. 80 New qua ntity (Q 1 ) = 200 units
∆P = P1 – P = 80 – 60 = Rs. 20 ∆Q = Q 1 – Q = 200 – 300 = – 100 units
We know tha t
∆Q P – 100 60
EP = ∆P × Q = 20 × 300 = – 1
Numerical Examples 7
Consider the following supply schedule:
Points A B C D
Price (PX ) 0 5 10 15
Supply (QX) 10 20 30 40
a. Compute the price elasticity of supply at the movement from B to C by
percentage method.
b. Compute the price elasticity of supply by arc method between C and D.
SOLUTION
a. Initia l qua ntity supplied (Q X) = 20
New qua ntity supplied (Q X1 ) = 30
Cha nge in qua ntity supplied (∆Q X) = Q X1 – Q X = 30 – 20 = 10
Initia l price of good X (PX) = Rs. 5
New price of good X (PX1 ) = Rs. 10
Cha nge in price of good X (∆PX) = 10 – 5 = 5
We know tha t
∆Q X PY 10 5 1
ES = ∆P × Q = 5 × 20 = 2 = 0.5 < 1
Y X

Interpretation: Since ES = 0.5 < 1, the supply is rela tively inela stic. One percenta ge
increa se in price results 0.5 percenta ge increa se in qua ntity supplied a nd vice -versa .
b. Initia l qua ntity supplied (Q X1 ) = 30
New qua ntity supplied (Q X2 ) = 40
Initia l Price (PX1 ) = Rs. 10
New Price (PX2 ) = Rs. 15
We know tha t
(Q X2 – Q X1) (PX1 + PX2 )
ES = (P – P ) × (Q + Q )
X2 X1 x1 X2

(40 – 30) (10 + 15) 10 25

= (15 – 10) × (30 + 40) =  5  × 70  = 0.71
   
Interpretation: Since, ES = 0.71 < 1, the supply is rela tively inela stic. One percenta ge
increa se in price results 0.71 percenta ge increa se in qua ntity supplied a nd vice-versa .
Numerical Examples 8
In 2012, 1,000,000 units of bread were sold at Rs 30 per unit in Bhatbhateni Super
Store. The price elasticity of demand for bread is – 0.2. The Bhatbhateni Superstore
has decided to increase price of bread to Rs 40 per unit for 2013.
a. What will be effect on total sales of bread in 2013?
b. Compute total revenue of bread for 2012.
c. Compute total revenue of bread for 2013.
d. Suppose you are appointed as a consultant of Bhatbhateni Superstore at
marketing department. What suggestion would you provide to the managing director
of the superstore about this pricing decision?

SOLUTION
Given
Initia l qua ntity of brea d (Q) = 1,000,000 units
Initia l price (P) = Rs. 30
Price ela sticity of dema nd (EP) = – 0.2
New price of brea d (P1 ) = Rs. 40
a. New qua ntity (Q 1 ) = ?
We know tha t
Q P
EP = ×
P Q
(Q 1 – Q) P
or, – 0.2 = (P – P) × Q
1
(Q 1 – 1‚000‚000) 30
or, – 0.2 = (40 – 30) × 1‚000‚000
or, – 66,666.66 = Q 1 – 1‚000‚000
 Q 1 = 933,333.34
The tota l sa les of brea d ha s increa sed beca use its dema nd is inela stic.
b. TR of bread for 2012 = P× Q
= 30 × 1‚000‚000
= Rs. 30‚000‚000
c. TR of bread for 2013 = P1 × Q 1
= 40 × 933,333.34
= Rs. 37,333,333.6
d. If I were appointed as a consultant of the Bhatbhateni superstore, I would give
suggestion to raise the price of bread because it has relatively inelastic demand. After
increase in price, there is increase total revenue.
Thank You