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    LAw OF DEMAND AND ELASTICITY OF DEMAND 2.1 DEFINITION AND FEATURES OF DEMAND Demand for a commodity is defined as the quantity of that commodity which is demanded at a certain price during any particular period of time. For example, a consumer demands 2 kg of wheat in a month at the price of Rs 20 per kg. This is a complete example of demand for a commodity as it has all the three components of demand—quantity, price and time. The main features of demand for a commodity are: (a) Demand depends upon utility of the commodity. A consumer is rational and demands only those commodities which provide utility. () Demand always means effective demand, i.e., demand for a commodity or the desire to own a commodity should always be backed by purchasing power and willingness to spend it, (c) Demand is a flow concept, i.e., so much per unit of time. (d) Demand means demand for final consumer goods. (e) Demand is a desired quantity. It shows con- sumers wish or need to buy the comme ae 3 oficiency Test (CPT) [D THE DEMAND FUNCTION at i factors Demand is a multivariate relationship, #.¢., itis ee om Bifor simultaneously. Some of the most important factors de rice, prices of other a commodity of an individual household are its OWN PHT Fe neous goods, consumers’ income, tastes and preferences. Some a ulation growth, factors affecting demand are income distribution, Pope eo caitions, government policy, wealth of the consumers, change in 24 General Economics for Common Pro 2.2 FACTORS DETERMINING DEMAND AN! tc. ete. tea ee one ing upon the four major variables is expressed symbolically in the form of a demand function: Dy =f(Px: Pz YT) where Dx = Demand for commodity X. Price of commodity X. Price of other good Z. ‘consumers’ income T = Consumers’ tastes and preferences. These factors affect demand in the following manner: (i) Price of the good (Inverse Relationship). As the price of a good f demand rises and vice versa. There is an inverse relationship be the price and demand for a good. It is known as the law of demand. (Gi) Price of other good. The other good Z can bea substitute or complementary good of good X. (a) Substitute goods (Direct Relationship). Substitute goods are those which are an alternative to one another in consumption. They satisfy same human want. For example, tea for coffee; rice for wheat; ink pen for ball pen; Pepsi for Coca Cola, ete. If the price of Z (say, Tice) rises it would cause an increase in demand for good X (say, is t). oe is a direct relationship between demand for a gc and price of its substitute s. It gives ri i 0 danas curve. oe ee (b) Complementary goods (Inverse Relationship). lementary goods are those which are jointly used to Cia, ae example, tea and sugar: car and petrol; penand ink; bread and butter; c and cigarette lighter, etc. If price of Z (say, petrol) rises, then quant demanded of X (say, car) will reduce, other things remainin 0g same. The demand curve when the two goods are con onta is negatively sloping indicating an inverse relati ‘aa (iii) Income of the consumer. How a change in income will affect the demand for a good depends upon the type of the good. (a) If Xisa normal good then with an increase in income, consumer buys more of the good. Goods whose demand rises when income rises are called normal goods. (b) If Xisa necessity then with an increase in income, initially its demand will rise but will become constant after some point. That is, even with more income, people will not consume more of a necessity like sugar, milk, medicine, salt, etc. (c) If X is an inferior good then an increase in income causes its demand to decrease. This is because as incomes rise, purchasing power rises and consumers substitute superior goods for inferior goods. Goods whose demand falls when income rises are called inferior goods. (iv) Tastes and preferences of consumers (Direct Relationship). Any change in consumers’ tastes and preferences in favour of the good causes its demand to increase and vice versa. 2.3 THE LAW OF DEMAND 1. Definition and Assumptions of the Law of Demand Definition. There is a definite inverse relationship between the price of the good and the quantity demanded of that good. Symbolically, Dy =f(Px), ceteris paribus Keeping other factors constant, the relationship between price and quantity demanded of a good is called the law of demand. It states that the consumer demands more of a good at a lower price and vice versa, other things being equal. In other words, the quantity demanded of a good is negatively related to the price of that good. It is a qualitative statement. Assumptions of the law of demand: The law is valid only when the following assumptions hold: (i) The price of the related goods remains the same. (ii) The income of the consumers remains unchanged. (iii) Tastes and preferences of the consumers remain the same. (iv) All the units of the goods are homogeneous. (2) Commodity should be a normal good. 2. The Demand Schedule and the Demand Curve The numerical tabulation of the law of demand is called the demand schedule. 2.1 shows a hypothetical demand schedule for wheat. ‘ 2.6 General Economics for Common Proficiency Test (CPT) Table 2.1 Demand Schedule for Wheat Price Quantity Demanded Reference (Rupees per kg) (kg per month) Point (Fig. 2.1) ou 6 A 80 5 B 40 4 c 50 3 F The demand schedule shows an inverse relationship between price and the quantity demanded. The consumer is willing to pay 50 rupees per kg to buy 3 kg of wheat each month. If the price reduces by 10 rupees per kg, he would be willing to buy an additional one kg per month and so on. This implies that lower the price more will be the demand and vice versa. The graphical representation of the demand schedule is called a demand curve. In Fig. 2.1, a demand curve for wheat is drawn which shows different quantities of wheat demanded at different prices in a month. Price (Rs per kg) Quantity (kg per month) Fig. 2.1 The Demand Curve The demand curve, d, slopes downward to the right or is negatively This law of downward sloping demand has been empirically tested verified. F 3. Reasons Behind Downward Slope of the Demand Curve The demand curve obeys the law of demand which States that there is an in) relationship between price and quantity demanded of a good. That is demand curve slopes downward to the right. The reasons behind downw: slope of the demand curve are: 1. Law of diminishing marginal utility: The law was formulated by Marshall and it states that as the consumer has more and more of a its marginal utility to him goes on declining. A consumer is not interested in buying more units of the same commodity at the same price. Instead, he is ready to pay a price equal to his marginal utility and marginal utility goes on diminishing. In other words, he is willing to pay a lesser price for more units ofa good. This implies that demand curve is downward sloping. 2. Substitution effect: When the price of a good rises, consumer feels that relative prices of other goods have reduced, so the consumer prefers to buy less quantity of the good whose price has risen. 3. Income effect: Increase in income means increase in the purchasing power of the consumer. With fall in the price of a good, consumer's real income or purchasing power rises and he demands more units oi the good. Thus, when price falls, demand rises. 4. New-consumers creating demand: As price of a commodity falls new consumers class appears, who can now afford the commodity. Thus, the total demand for the commodity increases, i.e., with fall in price, quantity demanded rises. 2.4 EXCEPTIONS TO THE LAW OF DEMAND There are certain cases where the law of demand gets violated. That is, there is a direct relationship between price and quantity demanded of a good. If price rises, demand also rises and vice versa. The situations where the law of demand does not hold are: 1. Giffen goods: The good is named after Sir Robert Giffen. Giffen good is necessarily an inferior good with very high negative income elasticity of demand. The good is consumed by low-paid wage earners who spend a large proportion of their income to buy it. Examples of Giffen goods are jowar and bajra. In case of Giffen goods, the demand curve is backward sloping (or upward sloping). 2. Goods of status or Conspicuous goods: The goods of status are named after Thorstein Veblen as Veblen goods. Veblen goods are prestigious goods. They promote social prestige of the holder. Prof. Veblen gave the example of diamonds. Diamonds and other precious stones are all status goods. Higher the price, more the demand for them. 3. Expectation of price rise in future: Consumer's expectations about price affect their buying behaviour. If price rises and the buyer expects further rise in Price then it causes increase in the quantity bought. The reverse also holds. For example, shares. 4. Demonstration effect: Sometimes, a section of society tends to imitate the consumption pattern of higher income groups or some popular film star. In this case, the law of demand gets violated because people demand more 2.8 General Economics for Common Proficiency Test (CPT) of that commodity which the upper class people are buying, even at higher prices. 5. Emergency: In case of emergencies like war, curfew, drought or famine, the law of demand does not hold. In such situations, there is general insecuri ty and fear of shortage of necessities. Hence, consumers demand more goods even at higher prices. 2.5 FROM INDIVIDUAL DEMAND TO MARKET DEMAND 1, Definition and Factors Affecting Individual and Market Demand An individual demand means quantity demanded of a good by an individual consumer at various prices per time period. A market demand is the aggregate of the quantities demanded by all consumers in the market at different prices per time period. Factors influencing individual and market demand are shown in Table 2.2. Table 2.2 Factors Affecting Individual and Market Demand Individual Demand 1. Price of the good 2. Price of other good 3. Income of the consumer 4. Tastes and preferences of consumers Market Demand 1. Price of the good 2. Price of other good 3. Income of the consumer 4. Tastes and preferences of consume 5. 6. z .. Number of consumers in the market . Distribution of Income Age and sex composition of population Demand Schedule and Curve , 4 Let there be two households A and B in the market for wheat. By aggregating or summing their individual demands, market demand is one Tt isshown ! in Table 2.3. ] 79 4 Table 2.3 Individual and Market Demand Schedules Price Individual Demand Schedule | Mé jarket Demand S (Rs per Kg) for wheat (Kg per month) ee Genie a Qe Q,+ Qs = 4 e 4 3 ie : 6 2 3 a 8 1 2 - ; Graphically, the market demand curve is a horizontal summation of the two individual demand curves. The derivation of the market demand curve is shown in Fig. 2.2. Demand Curve of Demand Curve of Market Demand Individual A Px Individual B Py Curve np aoo~ 45 @°3 4 5 6 7 BD & Fig. 2.2 individual Demand Curves and Market Demand Curve where d, and dg = Individual demand curves for two consumers A and B. D= Market demand curve. It is the horizontal or lateral summation of d, and d, curves at each and every price. It obeys the law of downward sloping demand. 2.6 MOVEMENT: EXPANSION OR CONTRACTION OF DEMAND A movement along the demand curve is caused by a change in the price of the good only, other things remaining constant. It is also called change in quantity demanded of the commodity. Movement is always along the same demand curve, i.e., no new demand curve is drawn. Movement along a demand curve can bring about: (a) Expansion of demand, or (b) Contraction of demand Expansion (or Extension) of demand refers to rise in demand due to fall in the Price of the good. Contraction of demand refers to fall in demand due to rise in the price of the good. Son 5 T) 2.10 General Economics for Common Proficiency Test (CPT) i in Fig. 2.3. Movement along a demand curve is graphically illustrated in Fig. Aon the demand curve d, is the original situation. Price ok ao Q 80 90 100 Quantity Fig. 2.3 Movement along Demand Curve An upward movement from point A to a point such as point B shows contraction or lesser quantity demanded at a higher price. A downward movement from point A to a point such as point C shows expansion or more quantity demanded at a lower price. 2.7 SHIFT: INCREASE OR DECREASE IN DEMAND A shift of the demand curve is caused by changes in factors other than price of the good. These factors are: (2) Consumers’ income (8) Prices of other goods (c) Consumers’ taste and preference A change in any of these factors causes shift of the demand curve. It called change in demand. Ina shift, a new demand curve is drawn. A shi demand curve can bring about: (a) Increase in demand, or (8) Decrease in demand. (a) Increase in Demand It refers to more demand at a given price or same demand at a higher price. The of increase in demand are: () Increase in the income of the consumers. (ii) Increase in the price of substitute goods. (iii) Fall in the price of complementary goods. (iv) Consumers taste becoming stronger in favour of the good. Increase in demand is graphically shown in Fig, 2.4. Inthe figure, dis the original demand price curve. An increase in demand is shown by rightward shift ofthe demand curve from d to d;. An increase in quantity demanded shows that: Pp ( either at original price of OP, more units (XX) of the good are demanded. In the original situation ° OX units were demanded. (ii) or same units (OX) are demanded Fig. 2.4 Shift in Demand Curve: Increase ata higher price of OP;. in Demand os xX Quantity (b) Decrease in Demand It refers to less demand at the given price or same demand at a lower price due to unfavourable changes in factors other than the price of the good. The causes of decrease in demand are: (i Fallin the income of the consumers. (ii) Fallin the price of substitute goods. (iii) Rise in the price of complementary goods. (i) Consumers’ taste becoming unfavourable towards the good. Decrease in demand is graphically shown in Fig. 2.5. Price fa x Quantity Fig. 2.5 Shiftin Demand Curve: Decrease in Demand Inthe figure,d is the original demand curve. A decrease in demand is shown by a leftward shift of the demand curve from d to d;. A decrease in demand shows that: (i) either at the original price of OP, lesser units (XX,) of the good are : demanded. In the original situation OX units were demanded. (ii) or same units (OX) are demanded at a lower price of OP). Table 2.4 summarises the difference in the causes of shift in the demand. 2.12 General Economics for Common Proficiency Test (CPT) Table 2.4 Difference in the Causes of Shift in the Demand Curve Increase in Demand [Upward or rightward shift in demand) (Downward or leftward 1. Decrease in the income of the consumers Decrease in Demand shift in demand 1. Increase in the income of the consumers. l2. Increase in the price of substitute goods. |2. Decrease in the price of substitute gc 3. Fall in the price of complementary goods. 8. Rise in the pace of complementary 4. Changes in tastes and preferences 4. Changes in tastes and preferences in favour of a commodity. against a | NT AND SHIETIOF THE DEMAND i 2.8 DIFFERENCE BETWEEN MOVEME! CURVE The difference between shiftand movementin the demand curve issummarised in Tables 2.5 and 2.6. Table 2.5 Difference Between Increase in Demand and Expansion of Dems Expansion of Demand 1. It refers to movement along a de curve, In this, there is a rightward shift of the 2. In this, the consumer moves to thé demand curve. right or downwards on the same demand curve. 3. Itis due to fail in the price of the commodity. Increase in Demand 1. It refers to shift of a demand curve. 2. 3. Itis due to (a) increase in consumers’ income. (b) Increase in the price of substitute goods. (©) fallin the price of complementary (d) favourable changes in consumers’ taste for this good. 4. Increase in demand is defined as the rise in demand at the same price of the commodity. 1. It refers to shift of a demand curve. 2. In this, there is a /eftward shift of the demand curve. 3. It is due to (a) fall in consumers’ income. (0) fall in the price of substitute goods. Theory of Demand and Supply 2.13 Table 2.6 Contd (@) rise in the price of complementary goods. (a) unfavourable changes in consumer's taste for this good. 4. Itis defined as fallin demand at the 4. It is defined as fall in demand due to same price of the commodity. rise in price of the commodity. 2.9 PRICE ELASTICITY OF DEMAND 1. Definition of Price Elasticity of Demand 2 The law ofdemand states that when the price of a good falls, consumers demand more units of the good. But how much more? It is important and useful to have an index which would indicate just how much responsive quantity demanded is to a change in price. The index is called price elasticity of demand. Price elasticity of demand measures the responsiveness of demand of a good to a change in its price. It is a quantitative statement. Alfred Marshall was the first economist to formulate the concept of price elasticity of demand as the | ratio of a relative change in quantity demanded to a relative change in price. A | relative measure is needed so that changes in different measures can be compared. These relative changes in demand and price are measured by percentage changes. Price elasticity is, thus, defined as a percentage change in quantity demanded of a good to a percentage change in its price. Numerically, price elasticity of demand, E, is calculated as: : 5, ~ Percentage change in quantity demanded 4 percentage change in price change in quantity demanded £,=_DFiginal quantity demanded change in price original price d AQ= Change in quantity demanded. Q= Original quantity demanded. AP = Change in price. P= Original price. E,= Coefficient of elasticity of demand. E, is negative. The ratio is a negative number because price and quantity 2a Generel Econamice for Common Proficiency Test (CPT) demanded are inversely related. In numerical sums, the ‘minus sign is dropped from the numbers and all percentage changes are treated as positive. 2. Determinants of Price Elasticity of Demand | } Factors which determine the price elasticity of demand for a commodity or — Service are: 1. Availability of substitutes: A good having close substitutes will have an elastic demand and a good with no close substitutes will have an inelastic demand, Commodities such as Luxor pen, Pepsi, Maruti car have close substitutes. When the price of these goods rise, the price of their substitutes remaining. constant, there is proportionately greater fall in the quantity demanded of these goods. That is, their demand is elastic. Commodities such as prescribed medicines and salt have no close substitutes and hence, have an inelastic demand. Income of the consumers: If the income level of consumers is high, the elasticity of demand is less. It is because change in the price will not affect the quantity demanded by a greater proportion. But in low income groups, the elasticity of demand is high. Nature of need that a commodity satisfies: The price elasticity of demand is likeM to be low for necessities and high for luxuries. A necessity is a good or service that the consumer must have, such as food bread, milk and medicines. Luxuries are goods that are enjoyable but not essential. Example, travelling by air, eating in a 5-star hotel, etc. If the price of necessities rise, then demand will not fall by a greater proportion because their purchase cannot be delayed. That is why, the price elasticity of demand in case of necessity is low. . Cost relative to total income: Higher the cost of the good relative to total income of the consumer, more will be the price elasticity of demand. If the prices of bread, ink, salt and match box, which is relatively low, doubles, it would have almost no effect on the quantity demanded of them. On the other hand, if price of car doubles then the quantity demanded will fail by a greater proportion showing more price elasticity of demand. Number of uses of the commodity: The more the number of uses a commodity can be put to, more elastic is the demand. If a commodity has few uses, it has an | | inelastic demand. Goods like milk, eggs and electricity can be put to many | different uses and hence, enjoys an elastic demand, ie., when prices are FP) 2 * wv low. demand increases by a greater proportion as the goods can now be put to less important uses also. | 6. Level of price: If the price of the commodity is high, the price elasticity of demand is more and if it is low, the price elasticity of demand is less. ; Before deciding whether the demand for a commodity is elastic or inelastic all the factors mentioned above must be simultaneously considered. Asummary of the: affecting elasticity of demand is given in Table 2.7.» . Theory of Demand and Supply 2.15 Table 2.7 Determinants of Price Elasticity of Demand Elasticity of demand is more when . More substitutes are available. The income of the consumer is less. . High priced luxuries are available. . Cost relative to total income. . The cost of the good is more. Number of uses of the purchased The number of uses of the good are commodity. more. .. Price level. . The price of the good is high Factors . Availability of substitutes. . Income of the consumers. Luxuries versus necessities. Arona aR eNa 2 2 2.10 MEASUREMENT OF PRICE ELASTICITY OF DEMAND There are three methods of measuring price elasticity of demand. These are: 1. Total Outlay or Expenditure Method. 2. Percentage or Proportionate Method. 3. Geometric or Point Method 1. Total Outlay or Expenditure Method Total outlay or expenditure by consumers are the revenues earned by the sellers. When price of a good changes, it brings about a change in the total revenue of the seller. The change in total revenue depends upon the price elasticity of demand. When price of a good changes, three situations can take place. When the price of a good falls and, as a result, if the total outlay of consumers on the commodity rises then E, > 1, if it remains unchanged then E,=1 and if it falls then E,< 1. The situation reverses when the price of a good rises. The explanation of these situations is as follows: Situation 1. Greater than One (E4> 1). When E, > 1, as price (P) falls quantity demanded (Q) increases in a greater proportion to a fall in price. Hence, total expenditure (P times Q) increases. In other words, price and expenditure are moving in the opposite direction. It is a case of elastic demand. It exists in case of normal goods. Situation 2. Equal to One (E, = 1). When E, = 1, as price falls quantity demanded increases in an equal proportion to a fall in price. Hence, total expenditure (Px Q) remains unchanged. That is, with a change in price, there is no change in the expenditure. It is a case of unitary elasticity of demand. fi epagion 3. Less than One (E, < 1). When E4 < 1, as price falls quantity emand eases in less than proportion to the fall in price. Hence, total aia falls. Thatis, price and expenditure are moving in the same direction. is a case of inelastic demand. It exists in case of inferior goods. 2. Percentage Method : Bt this method, E, is calculated by the following formula: 2.16 General Economics for Common Proficiency Test (CPT) E Percentage change in qualtity demanded SEE eee a Percentage change in price or pe moet The absolute value of the coefficient of elasticity of demand ranges from Zero to infinity (0 < E, < ), There are five types of price elasticity of demand. They are summarised in Table 2.8. Table 2.8 Different Values of Elasticity of Demand Coefficient | Type of Defination Type of Shape of of Ey E, Good _| Demand Curve| (See Fig. 2.6) 1.E,=0 | Perfectly This occurs when toa |Essentials | Vertical (dF) inelastic percentage change in _| like life | demand price there is no change | saving drugs in quantity demanded. 2.0 bw 25% = =25 - Es t0% _ Good X has an elastic demand. The demand curve for Good X will be fer showing more than proportionate change in quantity demanded to in price. the relationship between slope and elasticity of a demand curve? formula of elasticity of demand is: a The relationship between slope and elasticity of a demand curve is ae SP Bai Slope Q 4. A consumer spends Rs 40 on a good at a price of Re 1 per unit and Rs 60 at a price of Rs 2 per unit. What is the price elasticity of demand. What king of good is it? What shape will its demand curve take? Solution: Given, Original quantity (P) = Re 1 New quantity (P,) = Rs2 o Change in price (AP) = Re 1. From the expenditure (P x Q) figures of Rs 40 and Rs 60, quantity demanded figures can be calculated as follows: Rs 40 - emeiyaniivdemand (Q)= 2 = "> = 20 unis P Rs 1 f P,xQ, _ Rs60 / N tit oe = 30 units jew quantity (Q,) = Rey 730 uni Change in quantity demanded(AQ) = 10 units ae Sarapi 1) This occurs when the percentage change in quantity demanded is greater than. the percentage change in income. It is called high income elasticity. It takes place in case of luxury goods. 2. Equal to One (ey = 1) is occurs when the percentage change in quantity demanded is equal to the percentage change in income. It is called unitary income elasticity. It holds for those normal goods which fall between the category of necessities and luxuries. 3. Less than One (0 < ey <1) This occurs when the percenta ge change in quantity demanded is less than the Percentage change in income. It is call i ici i ee called low income elasticity. This takes place 4. Equal to Zero (ey = 0) This occurs when there in no change in inferior good. 5. Less than Zero (ey < 0) This occurs when the Percentage change in quanti with change in income. It is called negative itd clawticiy i a inferior and giffen goods. See Table 2.10 summarises the five different values of income kis : a an Theory of Demand and Supply 2.29 fates Table 2.10 Different Values of Income Elasticity Type of Good High Income elasticity Luxury good 2 Unitary income elasticity Normal good (which is a necessity as well as semi-luxurious) 3. Low Income elasticity Necessity 4 Zero Income elasticity Poor quality necessity Negative Income elasticity | Inferior Good 3. Solved Numerical Problems on Income Elasticity 1. If income of a household rises by 20%, then demand for car rises by 40%. Calculate income elasticity. What kind of good is car for this household? _ % change in demand Bete 829 Tosehange'in income _ 40% ~ 20% Since ¢, > 1, car isa luxury for this household. . Ifincome of a household rises by 20% then demand for rice rises by 10%. What kind of good is rice for this household? Solution: e, = 10% _ 95 20% Since ¢, is 0.5 which lies between 0 and 1 rice is a normal good for this old. If income of a household rises by 20% then demand for potatoes falls by 10%, then what kind of good is potatoes for this household? Solution: ¢, =— 10% -_95 ‘emis 20% Pie Since e, < 0, potatoes is an inferior good for this household. a CROSS ELASTICITY OF DEMAND P, = Initial price of 2 p= Initial quantity demanded of good x. ae iahange in nay demanded of good x. | AP, = Change in price of good 2. Cx, = Coefficient of cross-elasticity of demand. } 2. Types of Cross Elasticity of Demand The valus of cross-elasticity ranges from minus infinity to plus infinity. (- 0) This occurs when the two goods x and z are substitutes. The higher the numerical value of e,., the greater the degree of substitutability. If ¢,. = °°, then x and z are perfect substitutes. The positive sign on the e,, explains the positive relationship between the price of a good and the quantity demanded of its substitute. If the price of tea falls then the quantity demanded of its substitute, coffee, will fall. Thus, cross-elasticity between tea and coffee is positive. (b) Less than Zero (e,, < 0) This occurs when the two goods x and z are complements. The lower the numerical value of e,,, the greater is the degree of complementarity. If e,, = — then x and z are perfect complements. The negative sign on the ¢,, explains that when the price of a good increases the quantity demanded of its complements moves in the opposite direction. If the price of sugar increases, the quantity demanded of tea will fall. Thus, cross elasticity between tea and sugar is negative. (c) Equal to Zero (e,, = 0) This occurs when the two goods x and z are unrelated. That is, a change in the price of one good does not affect the quantity demanded of the other good. Table 2.11 summarises cross elasticity of demand. Table 2.11 Different Values of Cross Elasticity SI. No. Values ofex2 | Relationship Between X and 2 1. @X2=-c0 Perfect Complements 2. e x 2 is negative Complements 3. Ix2=0 No relation 4 ex 2is positive Substitute e ex2= Substitute Theory of Demand and Supply 2.25 3. Solved Numerical Problems on Cross Elasticity 1. If quantity demanded of ink pen rises by 5% when pri rises by 20%, then calculate cross elasticity onde ok Lapkele Solution: Since price of ball pen and quantity demanded of ball moving in the same direction, they are substitutes. The value a cross elasticity of demand will be positive. Cross elasticity of demand = © change in quantity demanded of inkpen 5% 20% % change in price of ballpen f= +025 2. Calculate cross-elasticity when quantity demanded of ink pen rises by 5% as price of ink falls by 20%. Solution: Since price of ink and demand of ink pen is moving in opposite direction, they are complements. The value of cross elasticity of demand will be negative. Cross elasticity = % change in quantity demanded of inkpen % change in price of ink 5% ~ 20% 1 = —=-0.25 4, 3. Calculate cross elasticity of demand when there is no change in quantity demanded of burgers in Delhi due to 20% fall in price of tomato sauce in Kanpur. Solution: Cross elasticity = — 0% _ ~ 20% % change in quantity demanded of burger in Delhi % change in price of sauce in Kanpur It means there is no relation between the two goods. Important Points To REMEMBER 1. The demand for a commodity is the quantity of the commodity which is at a certain price during any particular period of time. 2. Ineconomics, demand means effective nand which means there should be to own the good, sufficient money itand reds to spend the 3. The determinants of an individual household demand are (i) price of the good (Px), (ii) price of related goods (P;), (iii) income of the consumers (Y), and (iv) tastes and preferences of the consumers (7). ; 4 The law of demand states that there is an inverse relationship between price and quantity bought of a commodity, a, Cae Ee ceteris . The assumptions of the law of demand are that Pz, Y and T are constant. " — The demand schedule gives the data on changes in quantity bought at different prices in a particular time period. — Data is plotted on price—quantity axes to derive the demand curve. The demand curve slopes downward because of (i) law of diminishing marginal utility (as given by Marshall), (ii) income effect, (iii) substitution effect, and (iv) new consumers creating demand, 5. Exception to the law of demand are found in the following cases (i) Giffen goods, (ii) Conspicuous goods or goods of status, (it!) Expectation of a price rise in future, (iv) Demonstration effect, and (v) Emergency. 6. Individual demand is the demand on the part of a single consumer at various prices per time period. Market demand is the aggregate of the demand of all the consumers taken together at various prices per time period. ~ Factors influencing the individual demand are price of the good, price of related goods, income of the consumers and tastes of the consumers. The three additional factors determining the market demand are (i) Number of consumers in the market (ii) Distribution of income, and (iii) Age and sex composition of the population. Market demand curve is constructed by horizontally summing all the individual demand curves at each and every price. 7. Movement along a demand curve occurs due to changes in the price of the good (Px) itself. Shift of the 10. ii. . Price Elasti demand curve occurs due to in (i) price of other good (P,), (ii) income of the consumers (Y) ang (iii) tastes of the consumers (T). — Movement can be expansion oy contraction of demand whereas shif, can be increase or decrease jn | demand. y of Demand (Ej) measures percentage change in the quantity demanded of a good due ty a percentage change in its price, Therefore, Ey can be calculated as: Percentage change in demand Percentage change in price ag P AP Q The major determinants of pricé elasticity of demand are: (i) Availability of substitutes (ii) Income of the consumers, or=- (iii) Luxuries versus necessities (iv) Cost of the good relative to total income (2) Number of uses of the commodity (vi) Level of price. There are five degrees of Ey. (i) Perfectly inelastic demand (E4=0) (ii) Inelastic demand (Ej < 1) (iii) Unitary elastic demand (E, = 1) (iv) Elastic demand (E, > 1) | (2) Perfectly elastic demand (E,= | Measurement of Price Elasticity Demand The three methods of measuring are: (i) Outlay or expenditure method (i) Percentage or proportional ethod ts me (iit) Geometri int) n () Inthe outay method the (i In the percentage method, E, is calculated by the formula: -AO.P 4 APO For arc elasticity, the formula Q-@ B+Ph A+ h-P In the geometric method, E,at a point on a linear (straight) demand curve is calculated as: __ Lower side segment of the demand curve ‘4 Upper side segment of the demand curve isEj= (iii) 12. Income Elasticity of Demand measures changes in quantity demanded due to change in income of the consumer. The formula for calculating ey is: 13. 9 Income elasticity can be positive or negative, when ey > 1, the good is a juxury; when 0 ‘Since utility is an ordinal concept, no al values are given to indifference i ection nce curves is called an Good Y 3.8 ‘General Economics for Common Proficiency Test (CPT) is reflecting a different level of total utility; moving away from the origin, moves the consumer to higher levels of utility. 3. Features of Indifference Curve ‘There are three features of indifference curves as regards their shape. These are: 1. Downward Sloping to the Right re re i basic idea that if the quantity o} Any downward sloping curve expresses the u ce good is Bibeacted then the quantity of the other good has to be increased to ‘compensate’ the consumer and leave him with a new bundle equivalent to the first. a The downward slope of indifference curve can be proved by contradiction. Let us contradict the shape of an indifference curve. It has been graphically illustrated in Fig. 3.6. ra a ta Q, y B A A “a % ° Oe ° a Fig. 3.6 Proving the Downward Slope of an Indifference Curve by Contradiction Inall the three panels of Fig. 3.6, point B is preferred to point A as point B has more of the com: modity. The relation of indifference cannot exist between A and B. In other words, an indifference cannot b ‘d sloping, horizontal or vertical-it has to be downward slop Be bee ated ing. 2. Convex to the Origin aaa The Bae Beare can bea straight line, concave or convex to the 3 ence is that of slope—a straight line has same slope, a concave decreasing slope. The three — creasing slope and a convex curve has sloping curves are shown in Fig. 3.7. downward The slope of an indifference curve is Good Y called Marginal Rate of Substitution of X for Y, symbolically denoted as MRSxy. It is defined as the amount of Y that a consumer ' is willing to substitute for an additional unit of X. The slope measures the substitution. ax rate between the two goods. The slope of an indifference curve is shown in Fig. 3.8. ° Good X yes, Fig. 3.8 _ Indifference Curve is Convex to the Origin (ind Es | = oY _ MRSyy indifference curve ox MRSyyis the rate at which the consumer (trades off Y for X. MRSyy must be diminishing as consumer moves along the curve. This is because as the consumer has more and more of X, its subjective worth or marginal significance to him declines and that of scarce commodity Y goes up. He is willing to give up less and less of Y for an increment in X. Therefore, MRSxy is diminishing, .e., slope is diminishing. It implies indifference curve is convex to the origin. 3, They are Non Intersecting This is proved by contradiction. Let two % indifference curves intersect and see what they explain. Figure 3.9 shows two indifference ,, curves I,J, and 1], intersecting at point M. Point M and M, are lying on I,J, and by definition, the consumer would be indifferent between them. Similarly, consumer would be indifferent between M and M, lying on Ipl>. By _ the property of transitivity (assump-tion), a a me ramon i 2 1 Ne \ , has MTM, more of good Y. In other Other Helge 42) words, point M, must be preferred to M). Thus, contradictory result prevails. Hence, a, difference curves can never intersect each other. x 3.10 General Economics for Common Proficiency Test (CPT) Abudget constraintis graphically illustrated asa straight downward sloping line (see Fig. 3.10). where, OA = If the consumer spends all his income on good Y, he can buy OA units of Y. OB = If the consumer spends all his income on good X, he can buy OB units of X. AB= Budget line or consumption possibility line. ‘A consumer can buy any combination of X and Y that lies on or to the left of the budget line. Since, by assumption there are no savings (i... all income is spent), the consumer will be on the budget line. ‘AAOB = Right angled triangle formed by the budget line with the axes. It is called the budget set. Slope of _OA _ Px budget line|~ OB Py 5. Consumer’s Equilibrium Position and Conditions Aconsumer is in equilibrium when he maximises his utility, given income and market prices. In other words, equilibrium is attained where the consumer reaches the highest possible indifference curve given the budget constraint, This is shown graphically in Fig. 3.11. Equilibrium a in’ the Fig, Fig. 3.11 Consumer's Equilibrium I, ly Ty, 1, = Scale of preference of a consumer between the two Xand ¥ shown by an indifference map. || Pas AB = Budget constraint. en E= At point E, the consumer's budget line is tangent t indifference curve l,. It is the point of co ‘equi he a | 5 eemeebpermmmnnitacteleess: | Sa Prices of the two goods. At points E, [slope of indifference curve] = [slope of budget line] or MRSyy = % a ay _ Py loss of utility = gain in utility ax” dY=MUy and dX =MUuy of Muy _ Px Muy Py MUx _ MUy | ah or Py Py (1) and Diminishing MRS (2) The second condition is the condition of stability of the equilibrium. Note: Elasticity of Substitution Elasticity of substitution (e,) between two goods X and Y measures the ease with which one good can be substituted for the other. It is defined as the proportionate change in the ratio between the two goods divided by the proportionate change in their MRS. That is: % change in Y/X % change in MRSyy _AY/X_ | MRSxy AMRSyy —-Y/X @ ee & = 0, X and Y are perfect complements. Indifference curves are e,= tha oF (ii) ae =o, X and Y are perfect substitutes. Indifference c pa eine urves are straight 1. Rationality Both the theories assume that consumer is rational and aims at maximising his Satisfaction, given income and prices. 2. The Law of DMU and the Principal of Diminishing MRS The assumption of diminishing marginal utility is implicit in both the theories. In the indifference curve theory, indifference curves are convex to the origin implying diminishing MRSxy as more and more of good X is substituted for good Y. In other words, as the consumer has more of X, its marginal significance or utility to him declines. This is the law of DMU. Differences The points of differences between the two theories prove that indifference curve theor ry is superior to or more scientific than the utility theory. The points of difference are: 1. Cardinality versus Ordinality Marshall assumes that utility of each commodity is measurable and the most convenient measure is money. According to Hicks the consumer need not know the precise amount of satisfaction. He can order or tank his preferences, i.e., utility is an ordinal concept. 2. Income Effect Marshall assumes constant marginal utility of money and thus, ignores the income effect of a change in price of the good. Hicks incorporates the income effect of a change in price and does not make such unrealistic assumption as. constant marginal utility of money. 3. One Good versus Two Goods Marshall's concept of MU was with reference to one good. The law of DMU was accordingly stated as “As the consumer has more and more of a commodity, its MU to him diminishes”. Hicks’s concept of MRS was with reference to two goods X and Y and was symbolically denoted as MRSxy and read as MRS of X for Y. 4. Price Effect In Marshall’s theory, price effect due to change in price of a good is equal to the substitution effect. In Hicks’s analysis, Price effect is equal to substitution d income effects. Hicks’s theory clearly brings out the distinction b et these two effect and is hence, far superior ta Marshall's theory, 5. Giffen Paradox ‘ahha “ Marshall's theory fails to explain giffen 1 pit curve. Marshall derives adequately explain the can AOE G en 7 and Gif normal, inferior Va Important Points To REMEMBER it The logical basis of consumer behaviour has been explained by different theories. Some of the most important theories of consumer behaviour are: (i) Marshall’s Marginal Utility Theory . (ii) Hicks and Allen’s Indifference Curve Theory. . Marginal Utility Theory ~The law of diminishing marginal utility states that as the consumer has more and more units of a commodity, its marginal utility falls. — Utility is expected satisfaction toa consumer when he is willing to spend money on a stock of commodity which has the capacity to satisfy his want. — Marginal utility (MU) is addition made to total utility (TU) consump- tion is increased by one more unit. — When TU is maximum, MU is zero. Itis called saturation point. — When TU is rising, MU is falling. — The law of DMU is based on the assumptions that: (i) Standard unit of measurement is used (ii) All units of the good are (iii) Consumption is continuous ee HE ~ Marshall’s consumer surplus. = The amount consumer is willing to Aye ~ The amount he actually pays. = Area between the demand curve and the price axis above the price. Main limitations of this concept are: (@) Utility or satisfaction cannot be measured in money units. (ii) It is difficult to clearly define the amount consumer is willing to pay. Usefulness of the concept are observed in discriminating monopoly and taxation policy. . Indifference Curve Theory — Assumptions of the theory are: (i) Rationality (ii) Ordinality (iii) Diminishing marginal return of substitution (iv) Consistency and transitivity of choice (0) More is better Indifference curve shows different combinations of goods that yield the same level of satisfaction to the consumer. A family of indifference Curves is called an indifference map, ~ Features of indifference curve are: () Downward sloping to the right (ii) Convex to the origin (iii) They are non intersectin — Budget line shows all Slope of an indifference curve is called Marginal Rate of Substitu- tion (MRS). Aconsumeris in equilibrium when he maximises his utility, given income and prices. Equilibrium is teached at the point of tangency between indifference curve and budget line. Consumer equilibrim conditions are: Px Syy = Ek MRSyy B Mux _ Py i ot Muy RO) and Diminishing MRS (2) Elasticity of substitution between two goods X and Y measure the ease with which one good can be Substituted for the other. When two goods are perfect substitutes, indifference curve is straight downward sloping line. When two goods are perfect complements, indifference curve is L-shaped, 3:14 General Economics for Common Proficiency Test (CPT) ‘Comparison of Marginal Utility Theory with Indifference Curve Theory Hicks indifference curve theory ig superior to Marshall's marginal utili theory. It is clear from the following points: (i) Hicks does not measure utility in money units but only ranks them, (ii) Hicks takes into account income effect which is ignored by Marshall. (iii) Hicks concept of MRS was with references to two goods X and Y: Marshall's concept of MU was with reference to one good, (ie) Hicks analysis can classify the Boods into substitutes and complements, which Marshall ignores, (@) Hicks analysis can explain giffen Paradox. Marshall's analysis fails to explain giffen paradox. (vi) Hicks analysis splits price effect | into pure substitution effect and Pure income effet. The analysis is far superior to Marshall's analysis which ignores income effect. nt: Expansion or “Contraction of Supply Shift: Increase or. ‘Beoreave in Supply 4.1 CONCEPT OF SUPPLY 4. Definition of Supply Supply of a commodity means quantity of the commodity which is actually offered for sale at a given price during some particular time. Like demand, supply definition is complete when it has the following element (i) Quantity of a commodity that the producer + is willing to offer for sale; (ii) Price of the commodity; and (iii) Time during which the quantity is offered for sale. Example: Asupply statement is firm A supplies 50 kg of wheat at the price of Rs 10 per kg ina month 2. Difference Between Supply and Stock Stock of a commodity is the total quantity that is available in a market at a certain time. Supply is that part of the stock which a seller is ready to sell at a certain price during a certain time. Thus, supply is that part of stock which is actually brought into the market. For example, a producer has produced 400 pencils. This is the stock of pencils with him. He may be willing to offer for sale 100 pencils at the rate of Re 1 per pencil, 120 pencils at Rs 2 each; 150 pencils at Rs 3 each and so on. In this case, stock is 400 pencils, but the supply of pencils is different at different prices. J 4.2 General Economics for Common Proficiency Test (CPT) 4.2 FACTORS DETERMINING SUPPLY is difficult to There are a number of factors affecting supply of a commodity. It analyse the effect of all the factors on supply ‘simultaneously. Thus, we study the effect of any one factor on supply and other factors are assumed to be constant. Supply function is a functional relationship between quantity supplied of a commodity and factors affecting it. Supply function can be written as: Sx = f(Ps, Pz, T, C, Ex. Gr) where Sy = Supply of commodity X f= function of Px = Price of commodity X Pz = Price of related good, Z T = State of technology C = Cost of production r | Ey = Expected price of commodity X Gp = Government policy The explanation of these factors is as follows: (i) Price of the commodity (Direct Relationship). At a higher price, producer offers more quantity of the commodity for sale and at a lower price, less quantity of the commodity. (ii) Price of related good (Z). Supply of a commodity depends upon the prices of its related goods, specially substitute goods. If the price of a commodity remains constant and the price of its substitute good Z increases, the producers would prefer to produce substitute good Z. Asa result, the supply of commodity X will decrease and that of substitute good Z will increase. (iii) State of technology. If there is a change in the technique of production leading to a fall in the cost of production, supply of commodity will increase. (iv) Cost of production. A change in the cost of production, i.e., prices of factors of production also affects the supply of a commodity. If wages of labour increase then cost of production will rise. As a result, supply of the good will fall because producers would prefer to produce some other commodities that can be produced at a lower cost. (v) Expected price of commodity X. If the producers expect an increase in Price in the near future, they will reduce the current supply so as to offer more goods at higher prices in the future. (vi) Government policy. Government's policy also affects the supply of a commodity. If heavy taxes are imposed’on a commodity, it will discourage producers and as a result, its supply will decrease. On the other hand. concessions induce producers to raise the supply. 7 . 4.3 THE LAW OF SUPPLY 1. Definition and Assumptions of the Law of Supply Law of supply derives the relationship between price and quantity supplied. According to the law of supply, other things remaining the same, quantity supplied of a commodity is directly related to the price of the commodity. In other words, other things remaining the same, when price of a commodity rises, its quantity supplied increases and when its price falls, quantity supplied also falls. symbolically, the law of supply is expressed as: Sx = iP), ceteris paribus Assumptions of the Law of Supply. The law of supply is based on the assumption that all factors, other than the price of the commodity, that affect the supply, remain the same, i.e., (i) Price of related goods remains the same. (ii) State of technology remains the same. (iii) Cost of production remains the same. (iv) Future price of the good remains the same. (v) Government policy remains the same. 2. The Supply Schedule and the Supply Curve Supply schedule is a tabular statement that gives the law of supply, i.e., the different quantity supplied of a commodity at different prices per unit of time. A hypothetical supply schedule of wheat is given in Table 4.1. Table 4.1 Supply Schedule of Wheat Price Quantity Supplied ] Reference Point (Rs per Kg) (kg 1 month) | (Fig. 4.1) 1 5 A 2 8 B 3 12 c The supply schedule obeys the law of supply, i.e., as price of wheat rises, its supply also rises. Supply curve shows graphically the relationship between quantity supplied of a commodity to its price. The curve shows positive or direct relationship between the price and quantity supplied of the commodity. With rise in price, the curve rises upward from left to the right as shown in Fig. 4.1. where, SSis the upward sloping supply curve obeying the law of supply. Fig. 4.1. The Supply Curve 3. Reasons Behind Upward Sloping Supply Curve ‘The main reasons behind an upward sloping supply curve are: : (i) Law ofdiminishing marginal productivity. The law states that as more units of variable factor are employed, the addition made to total production falls, i.e., cost of production rises. Thus, more quantity is supplied only at higher prices so as to cover the rise in cost of production. (ii) Goal of profit maximisation. The aim of producers is to maximise profits. The aim canbe achieved by raising price of the goods. At higher price producers increase supply of goods. « 4.4 FROM INDIVIDUAL SUPPLY TO MARKET SUPPLY a | 1. Construction of Individual and Market Supply Schedule An individual supply schedule indicates different quantities offered for sale by an individual firm at different prices. A market supply schedule reflects total quantities of the commodity offered for sale by all the individual firms at different prices in a particular time period. Thus, market supply is obtained by aggregating the supplies of all firms selling that commodity at alternative prices. Suppose, there are only two firms A and B in the market for wheat. Individual supply schedules and the resultant market supply schedule is given in Table 4.2. Table 4.2 Construction of Market Supply Schedule Price Individual Supply Schedules | Market Supply Schedule (Rs per Kg) (Kg per month) bea Firm A Firm B (Kg per month) 3 12 13 25 e a ei 14 1 e B 11 2. Construction of Individual and Market Supply Curve supply curve is a graphical representation of a supply schedule. Individual supply curve reflects an individual supply schedule and market supply curve represents a market supply schedule. Market supply curve is obtained by horizontal summation of all individual supply curves as shown in Fig. 4.2. Market Supply i i 4 [Aptian ( i. O 6 8 12 suppy © 5/6 13'Supply 11 14 25 Supply Fig. 4.2 Construction of Market Supply Curve In the figure, quantity supplied is taken on the x-axis and price at which commodity is supplied on the y-axis. $,, and S, are individual supply curves. $$ is the market supply curve which is obtained by horizontally aggregating, S, and S;, at each level of price. 4.5 MOVEMENT: EXPANSION OR CONTRACTION OF SUPPLY A movement along the supply curve is caused by changes in the price of the good, other _ things remaining constant. It is also called change in quantity supplied of the commodity. In a movement, no new supply curve is drawn. Movement along a supply curve can bring about: @) Expansion or extension of supply, or “W) Contraction of supply Expansion or extension of supply refers to rise in supply due to rise in price of the good. Contraction of supply refers to fall in supply due to fall in the price of the good. Movement along a supply curve is graphically shown in Fig. 4.3. Point Aon the supply curve, S, is the original situation. 446. Conn Ecmamies or Common Profiecy Test (CPD 5 ae is C shows expansio : upward movement from point A to. point aust int such as point SI ae higher price. nen from point A toa por Bohs contraction or less supply at a lesser price. IECREASE IN SUPPLY % 4.6 SHIFT: Onn Di ane ee than the price of A shift in supply curve is caused by changes # the good. These factors are: (a) Price of other commodities (B) State of technology (©) Cost of production (@ Government policy (e) Expected price of the commodity. : A change in any of these factors causes shift in the supply curve. It is lpr called change in supply. In shift, a new supply curve is drawn. A shift of the supply curve can bring about: @) Increase in supply, or (0) Decrease in supply. (a) Increase in supply: When supply of a commodity rises due to favourable changes in factors other than price of the commodity, it is called increase in supply. Favourable changes imply: @ Improvement in technique of production (i) Fallin the price of substitute goods (iii) Fall in the cost of production (iv) Favourable charges in government policy (®) Fallin the expected price of the good Increase in supply is graphically shown in Fig. 4.4 where quantity supplied is measured on the x-axis and price of the commodity on the y-axis. ‘ Px * 20 —*30 Ox Fig. 4.4 Shiftin Supply Curve: Increase in Supply SS is the original supply curve. An increase in supply is shown by ri shift of the supply curve from SS to $,5;. An increase in supply (i) either at the original price, more ynits of the good are supplied. (ii) or same units are supplied at a lower price Theory of Demand and Supply 4.7 (b) Decrease in Supply: When supply of a commodity falls due to unfavourable changes in factors other than its price, it is called decrease in supply. The causes of decrease in supply are: () Obsolete technique of production ) Increase in the price of substitute goods (iii) Increase in the cost of production (iv) Increase in the expected price of the good (v) Unfavourable changes in government policy. Decrease means same quantity is supplied at a higher price or less quantity is supplied at the same price. ° 10 <— 20 ‘Supply Fig. 4.5 Shift in Supply Curve: Decrease in Supply In Fig. 4.5, SS is the original supply curve. A decrease in supply is shown. by leftward shift of the supply curve from $S to $,5;. A decrease in supply shows that: (i) either at the original price lesser units of the good are supplied. (ii) or same units are supplied at a higher price. The difference in the causes of increase and decrease in the supply is summarised in Table 4.3. Table 4.3 Difference in the Causes of Shift in the Supply Increase in Supply (Rightward shift of supply) 1. Improvement in techniques of Production. 2. Fallin the price of substitute goods. 3. Fallin cost. 4. Favourable changes in the goals of _ the firm and government policy. | 5. Fall in the expected price of the good. . Technique of production becoming . Rise in the price of substitute goods. . Rise in cost. . Unfavourable changes in government . Rise in the expected price of the good. | Decrease in Supply (Leftward shift of supply) obsolete. policy. 48 General Economics for Common Proficiency Test (CPT) 4.7 DIFFERENCE BETWEEN MOVEMENT AND SHIFT OF THE SUPPLY _ CURVE. The difference is summarised in Tables 4.4 and 4.5. Table 4.4 Difference Between Increase and Expansion of Supply Increase in Supply Expansion of Supply 1. Itis shift of supply curve, 4. Itis movement along a supply curve. 2. In this there is a rightward shift of 2. In this there is an upward movement the supply curve. along the supply curve. 3. It is due to favourable changes 3. Itis due to rise in the price of the in factors like commodity. (a) improvement in technique ot production. (b) Decrease in cost of production (c) Decrease in price of related goods. 4, It is defined as rise in supply at the 4. Its defined as the rise in supply at same price of the good higher price of the good. Table 4.5 Difference Between Decrease and Contraction of Supply a Decrease in Supply | Contraction of Supply 1. Itis shift of supply curve. 1. Itis movement along a supply curve 2. In this there is a /eftward shift of 2. In this the consumer moves to the left the supply curve. ‘on the same supply curve. 3. Itis due to 3. Itis due to fall in the price of the good. () obsolete technology. (b) tise in cost. (c) tise in the price of related goods. 4, Itis defined as fall in supply at the 4. Itis defined as the fall in supply at same price of the good. lower price of the good. 4.8 ELASTICITY OF SUPPLY Alfred Marshall developed the concept of elasticity of supply. Price elasticity of supply is defined a3 the responsiveness of quantity supplied of a commodity to changes in its own price. The value of elasticity of supply will give the degree or quantity of change in supply toa change in price. It is calculated as: E,= Percentage change in quantity supplied Percentage change in price aQ P AP Q Theory of Demand and Supply 49 Eg = Coefficient of price elasticity of supply P = Initial price of the good Q = Initial quantity supplied AQ = Change in quantity supplied AP = Change in price The positive sign indicates that price and quantity supplied of a good are positively related, ie., greater units of the good will be placed in the market only at higher prices and vice versa. 4.9 MEASUREMENT OF ELASTICITY OF SUPPLY 4. Percentage Method Elasticity of supply is measured by the formula: _ Percentage change in quantity supplied Ba ——— Percentage change in price popes aP Q There are five degrees or types of elasticity of supply. They are summarised in Table 4.6. Table 4.6 Values of Elasticity of Supply Coeff. of Types of Definition ‘Shape of Supply Es Es Curve (see Fig. 4.6) 1.E,=0 | Perfectly This occurs when to a percentage| Vertical (S3N) inelastic supply | change in price there is no change in quantity supplied. 2.0

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