PRICE ELASTICITY OF DEMAND AND ITS APPLICATION

Demand
A Common man·s Definition: 
The

desire or want for something.

But, The Concept of Demand many be looked upon as:

Definition of Demand

The demand for a product refers to the amount of it which will be bought per unit of time at a particular price.

Consumer Demand for a product may be viewed at two levels: 
Individual

Demand y The demand for a commodity from the individual point of view.  Market Demand y Total demand of all the buyers, taken together.

Determinants Of Demand

Factors Influencing Demand
Price of the Products y Income y Tastes, Habits and Preferences y Standard of Living y Number of Buyers in the market & Growth of Population y Age Structure & Sex ratio
y

Factors Influencing Demand ( Contd«) Contd«)
Level of Taxation and Tax Structure y Inventions and Innovations y Fashions y Climate or Weather Conditions y Customs
y

Demand Schedule 
A

tabular statement of price / quantity is called the demand schedule.  Two Types: y Individual·s demand schedule y Market demand schedule

Individual·s demand schedule
Price of Mangoes (Rs. Per kg) 80 70 60 50 40 Amount Demanded per Week (Quantities in kg) 2 4 6 10 16

Market Demand Schedule
Price ( in Rs. ) 4 3 2 1 Units of Commodity X Demanded per Day by Individuals A B C 1 2 3 5 1 3 5 9 3 5 7 10 Total or Market Demand (A+B+C) 5 10 15 24

Demand Curve
A Demand Curve is a graphical presentation of a demand schedule. y Price and Quantity information of a demand schedule is plotted on a graph. y Depicts the picture of the data contained in the demand schedule.
y
Fig. A Linear Demand Curve

Derivation of Market Demand Curve
A Market Demand Schedule A Market Demand Curve

Price ( in Rs. ) 4 3 2 1

Total or Market Demand 5 10 15 20 Quantity Price

The Law of Demand
It is the general tendency of consumers· behavior in demanding a commodity in relation to the changes in its price. y Demand varies inversely to the changes in price. y Statement of the Law of Demand:y

The Higher the price of the commodity, the smaller is the quantity and lower the price, larger the quantity.

Price Elasticity of Demand
´Price elasticity of demand is defined as responsiveness in the quantity demanded for a commodity as result of change in price of the same commodity.µ

Formula
The price elasticity of demand (Ep) is given by percentage change in quantity demanded percentage change in price

Determinants of Elasticity
y Substitutes y Percentage y Necessity y Duration

of Income

Types of Price Elasticity
yPerfectly

Elastic yPerfectly Inelastic yUnit Elastic yElastic yInelastic

Perfectly Elastic
y

An increase in price results in no change in consumers purchases

(a)

Quantity/ time

Perfectly Inelastic
y

A % increase in price leads to a larger % reduction in purchases.

(a)

Quantity/ time

Inelastic
y

The percentage change in quantity demanded is greater than that in price.
2 1

(110 - 100) (110 + 100) ($1 - $2) ($1 + $2)

= ( - ) 0.14 Elasticity = (-) 0.14

D
100 110

Quantity demanded

Elastic
y

The percentage change in quantity demanded is smaller than that in price.

(20 - 10) (20 + 10) ($10 - $11) ($10 + $11)

= (-) 7.0 Elasticity = (-) 7. 0

D
10 20

Effect on Revenue
P 9 8 7 6 5 4 3 2 1 0 Q 0 1 2 3 4 5 6 7 8 9 E Infinity -8 -3.5 -2 -1.25 -0.8 -0.5 -0.3 -0.125 0 TR 0 9 14 18 20 20 18 14 8 0

INELASTIC
y y y y y y y

BASIC / URGENT REQUIREMENTS HEALTHCARE FACILITY FOOD WATER HOUSING ALCOHOL DRUGS,CIGERATTES

INELASTIC ELASTIC
y y y y

MEDICINE ² ASPIRIN - PAINKILLER P.E - RELATIVELY ELASTIC MANY SUSTITUTES TAMIFLU - ANTI SWINE FLU P.E - PERFECTLY INELASTIC

y y

ELASTIC
y

INELASTIC

RESIDENTIAL ELECTRICITY y 1947 ELASTIC y 2009 RELATIVELY INELASTIC PETROL y 1901 y 2009
y y

ELASTIC RELATIVELY INELASTIC

COKE SUBSTITUTES ELASTIC RELATIVELY INELASTIC FOR ENTHUSIASTS

MORE PRICE ELASTICITY
BUTTER CHICKEN PORK FRUITS BEER WINE CIGARETTES CLOTHING CAR LEGAL GAMBLING MEDICAL INSURANCE RESIDENTIAL ELECTRICITY .24 .30 .77 3.02 .20 .67 .51 .51 16.99 1.9 .31 .13

Gasoline pinch
y

Due to oil shocks in 1974

y

Gasoline prices

SHORT TERM

LONG TERM

y

Gas Guzzlers replaced

y

No alternative Little demand fluctuation

y

Fuel efficient automobile y Switched to car poolS y Public transport y Alternative Energy ² nuclear, wind , solar
y

PRICE
GASOLINE

ELASTICITY
.43

(SHORT TERM)

GASOLINE

(LONG TERM)

1.50

ELECTRICITY

(SHORT TERM)

.28

ELECTRICITY

(LONG TERM)

.90

Applications
Large crop yield y Excise taxes y Decriminilization of Illegal Drugs
y

Barista

y

Mid 2003 - prices 25 % Per cup prices

Cappuccino coffee Barista Frappe Classic cold coffee

40 55 45

30 40 33

15 %

IN REVENUE (APRIL-MAY 2003)

Target group ² college goers , young proff. AFFORDABILITY

Any Questions?

THANK YOU!

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