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Elasticity of Demand

Meaning of Elasticity
• Elasticity of demand measures the responsiveness of demand due to the change in the factor affecting demand Price Elasticity of Demand It is the absolute value of the ratio of percentage change in the quantity demanded to the percentage change in price ep = |(dQ/Q) / (dP/P)| = |(dQ/dP) / (P/Q)|

e=0 = no change in demand • e>1 = elastic demand . e=infinity = infinite demand • e=1 = unitary demand .• e<1 = inelastic demand.

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Unitary Elastic demand .

ep = [(Q2-Q1)/{(Q2 +Q1)/2)}] X [(P2-P1)/{(P2 +P1)/2)}] . 1 to Rs. an increase in price from Re. ep = -{(dq/dp) X (P/Q)} • Arc Elasticity : This is used for analyzing the effect of discrete changes in price i.Measurement of Elasticity • There are two approaches to computing price elasticities.The choice between the two depends on available data & the intended use. 3 can be evaluated by computing the arc elasticity.e. • Point Elasticity : This is used when there is an extremely small change in price or we need to find the price elasticity of demand at any particular price.

• Point Elasticity .

• Arc Elasticity .

ec = %dQx / %dPy = (dQx /dPy) / (Py/Qx) • Substitute goods : ec >0 • Compliment goods : ec<0 . which is defined as the percentage change in quantity demanded of one good caused by a 1% change in the price of some other good.Cross Elasticity of Demand • The responsiveness of quantity demanded to changes in price of other goods is measured by cross elasticity.

When other factors are held constant.Luxury good ei=0 .Inferior good ei>1 .Neutral good . the income elasticity of a good or service is the percentage change in demand associated with a 1 percent change in income. ei = %dQ / %dI = (dQ/Q) / (dI/I) • ei>0 – Normal good ei<1 – Necessary good • • ei<0 .Income Elasticity • It is used to measure the responsiveness of demand to changes in income.

Engel Curve-When quantity demanded of good x is plotted against income then the derived curve is termed s engel curve .

so PXQ also falls • E<1 – As P rises by 1 unit Q falls but less than 1 unit. so PXQ rises • E=1 – As prices by 1 unit. Q falls by 1 unit.Effect of elasticity on Revenue • Revenue for Q unit sold at P/per unit price is PXQ • E>1 – As P rises by I unit q falls greater than 1 unit. so PXQ remains unchanged .

Elasticity of Supply It refers to the percentage change in quantity supplied of a product to one percent change in its price. es = |(dQ/Q) / (dP/P)| = |(dQ/dP) / (P/Q)| .

Types of Supply Elasticity When elasticity of supply Known as is Equal to infinity More than 1 but less than infinity Equal to 1 Less than 1 but more than 0 Equal to 0 Perfectly elastic supply Relatively elastic supply Unitary elastic supply Relatively inelastic supply Perfectly inelastic supply .

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Market Equilibrium .

Shifting of Equilibrium due to shift in dd curve .

Shifting of equm due to shift in supply curve .

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Shift in both supply & demand .

Demand and supply shifts If demand rises The demand curve shifts to the right The demand curve shifts to the left The supply curve shifts to the left The supply curve shifts to the left Effect on price and quantity Both price and quantity increses Both prices and quantity falls Price falls but quantity increase Price increases and quantity decreases If demand falls If supply rises If supply falls .

Eg.Factors determining Price Elasticity of demand • Availability & closeness of substitute: fewer the close substitute. less elastic the demand for the product. eg. The demand is relatively inelastic . Price of sugar • Time Period: Demand is more elastic in the long run than in the short run. Movie tickets & VCD players • Proportion of income spent on the product : Demand tends to be inelastic for those products and services that account for a small proportion of consumer’s total expenditure eg. Petrol car & diesel car • Habit formation : Some products are consumed more due to habits of consumers like cigarettes.

Application of Price elasticity of demand  Pricing decision of business organization  Pricing regulations by government  Paradox of plenty  Use in international trade  Fiscal policy • Application of cross price elasticity of demand • Application of income elasticity of demand .

Determinants of Price Elasticity of Demand • • • • Necessities versus Luxuries Availability of Close Substitutes Definition of the Market Time Horizon .

The more broadly defined the market. . The smaller the number of close substitutes. If the time period is shorter.Determinants of Price Elasticity of Demand Demand tends to be more inelastic • • • • If the good is a necessity.

the more narrowly defined the market. the longer the time period.Determinants of Price Elasticity of Demand Demand tends to be more elastic : • • • if the good is a luxury. • . the larger the number of close substitutes.