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ELASTICITY OF DEMAND

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The Law of Demand gives only the


direction of change of quantity
demanded in response to a given
change in the price of a
commodity,
But not the magnitude of such a
change.

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Responsiveness of a commodity is
the amount by which its quantity
demanded changes in response to
a given change in any of the
determinants of demand

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Elasticity the concept


The responsiveness of one variable
to changes in another
When price rises, what happens
to demand?
Demand falls
BUT!
How much does demand fall?
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Elasticity the concept


If price rises by 10% - what
happens to demand?
We know demand will fall
By more than 10%?
By less than 10%?
Elasticity measures the extent
to which demand will change
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Elasticity

3 basic types used:


Price elasticity of demand
Income elasticity of demand
Cross elasticity

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PRICE ELASTICITY OF
DEMAND

Price elasticity of demand


measures the proportionate
change in quantity demanded of a
commodity to a given change it is
price.
It means the sensitivity of quantity
demanded of a commodity to a
given change in its price.
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Elasticity
Price Elasticity of Demand
The responsiveness of demand
to changes in price
Where % change in demand
is greater than % change in price
elastic
Where % change in demand is less
than % change in price - inelastic

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Degrees of Price Elasticity

Perfectly Elastic Demand


Highly Elastic Demand
Unitary Elastic Demand
Relatively Inelastic Demand
Perfectly Inelastic Demand

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Perfectly Elastic Demand


This is the one extreme of
elasticity range, when elasticity is
equal to infinity i.e., ep = Infinity
The unlimited quantities of the
commodity can be sold at the
prevailing price and even a
negligible increase in price would
result in zero quantity demanded.
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Highly Elastic Demand


When proportionate change in
quantity demanded is more than a
given change in price, the
commodity is regarded to have a
highly elastic demand.
A small decrease in price from p1
to p2 leads to a proportionately
greater increase in quantity
demanded from Q1 to Q2
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Unitary Elastic Demand


When a given proportionate
change in price brings about an
equal proportionate change in
quantity demanded, then demand
for that commodity is regarded as
unitary elastic.
The fall in price, equal to p1- p2,
results in an equal increase in
quantity demanded, equal to Q2
Q1.

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Relatively Inelastic Demand


When change in quantity
demanded is found to be offset by
change in its price, then the
commodity has a relatively
inelastic demand. i.e., ep<1
There is a large decrease in the
price of the commodity from p1 to
p2 leads to a comparitively small
increase in its quantity demanded,
from Q1 to Q2
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Perfectly Inelastic Demand


This is the another extreme of the
elasticity range in which elasticity
is equal to zero, (ep=0)
The quantity demanded of a
commodity remains the same,
irrespective of any change in price,
At all price levels, OP1 & OP2
quantity demanded remains
constant.
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Methods of Measuring
Elasticity
Ratio or percentage Method:

ep=Proportionate change in quality


demanded of commodity X /
proportionate change in price of
commodity X

Arc Elasticity Method


Total Outlay Method

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Elasticity
Price ()
The demand curve can be a
range of shapes each of which
is associated with a different
relationship between price and
the quantity demanded.

Quantity Demanded

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INCOME ELASTICITY OF
DEMAND

The degree of responsiveness of


demand for a commodity to a
given change in the income of the
consumer.
ep= Proportionate change in quantity
demanded of commodity X /
proportionate change in income of
consumer
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Degrees of Income Elasticity

Perfectly elastic (ey = infinity)


Perfectly inelastic (ey = 0)
Relatively elastic (ey > 1)
Relatively Inelastic (ey < 1)

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Types of Income Elasticity of


Demand

Positive Income Elasticity: a good


that has positive income elasticity
is regarded as normal good. Eg
clothes, food,fruits
Zero Income elasticity: implies
that there is no change in the
demand for a commodity when
there is a change in income
(neutral goods like match box, salt
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Negative Income Elasticity: the


demand for a commodity
decreases as the income of the
consumer rises.
Examples would be inferior quality
of cereals, a consumer would
switch over consumption to
superior quality with increase in
income.
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CROSS ELASTICITY OF
DEMAND

It explains the responsiveness of


demand for one good to the
changes in price of another related
good
ec=proportionate change in qty
dd of commodity X / proportionate
change in price of commodity Y

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Determinants of Elasticity
Time period the longer the time under
consideration the more elastic a good is likely
to be
Number and closeness of substitutes
the greater the number of substitutes,
the more elastic
The proportion of income taken up by the
product the smaller the proportion the more
inelastic
Luxury or Necessity - for example,
addictive drugs
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Importance of Elasticity
Relationship between changes
in price and total revenue
Importance in determining
what goods to tax (tax revenue)
Importance in analysing time lags
in production
Influences the behaviour of a firm
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