Elasticity of Demand

Part - II
Concept of Elasticity of Demand
The demand and supply state only the nature, not the extent
of relationship between change in price and quantity demanded,
and quantity supplied.

Law of demand does not tell us about the percentage change in

quantity demanded due to certain percentage change in price.
Thus, to measure the degree of relationship between price and
quantity demand, Alfred Marshall, developed a new
economic tool i.e Elasticity of Demand.
 What is Elasticity of Demand?
Elasticity of demand is the measure of responsiveness of
demand for a commodity to the change in any of its
determinants, i.e
Price of commodity
Price of substitute and complementary goods
Consumer’s income
Consumer’s expectation regarding price etc.

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 Types of Elasticity

1. Price Elasticity of Demand

2. Income Elasticity Demand
3. Cross Elasticity of Demand
4. Elasticity of price expectation

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 Price Elasticity of Demand
Price Elasticity of demand is the percentage change
in the quantity demanded of a commodity as a result of a
certain percentage change in its price.

A formal definition of price elasticity of demand (E p) is

(Ep) =

(Ep) =

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Types of Price Elasticity of Demand

1. Perfectly Inelastic demand (Ep = 0)

2. Relatively Inelastic demand (Ep ‹ 1)
3. Unitary Elastic demand (Ep = 1)
4. Relatively Elastic demand (Ep › 1)
5. Perfectly Elastic demand (Ep = ∞)

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 Perfectly Inelastic Demand
Perfectly inelastic demand (Ep = 0): If there is no
response in quantity demanded due to a change in it’s
price is said to be perfectly inelastic demand.

E.g. demand of salt and medicine can’t be changed

whether the price changes.

Graphically,

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 Relatively Inelastic Demand
Relatively inelastic demand (Ep ‹ 1): If percentage
change in quantity demanded is less than percentage
change in it’s price, it is said to be a relatively inelastic
demand.

It is related with the daily consumption good. E.g Wheat,

Rice, Pulses etc.
Graphically,

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 Unitary Elastic Demand
Unitary elastic demand (Ep = 1): If percentage
change in quantity demanded is equal to the
percentage change in it’s price, it is said to be a
unitary elastic demand.
Graphically,

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 Relatively Elastic Demand
Relatively elastic demand (Ep › 1): If percentage
change in quantity demanded is greater than percentage
change in it’s price, it is said to be a relatively elastic
demand.

It is related to luxury goods. E.g. Demand for electronic

products.

Graphically,

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 Perfectly Elastic Demand
Perfectly elastic demand (Ep = ∞): If a very small
change in price of commodity leads to infinity change in
it’s demand, it is said to be perfectly elastic demand.

It is perfectly hypothetical concept.

Graphically,

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In Totality

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 Measurement of Price Elasticity
Measurement of price elasticity of demand is
on the basis of different methods as:
Point method
Arc method
Total outlay method &
Percentage method

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 Point Method
Point elasticity is the measure of price elasticity at
a finite point on a demand curve.
It is useful, when change in price and the
consequent change in quantity demanded is very
small.

It refers to measuring the elasticity at a

particular point on demand curve.

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 Point Elasticity of Demand
Y

Point Elasticity = Upper

Lower Segment
Segment E=∞
M
PN E>1

PM A
E =1
As we move from N to M,
elasticity goes on increases at P
mid point, Ep = 1, at N, Ep = E<1
B
0 and at M, Ep = ∞ Mid E =0
Point
X
O N
Quantity
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 Arc Elasticity of Demand
When elasticity is to be found Y
between two points, we use Arc
elasticity. P1 A Arc Elasticity

Elasticity =  q1  p1  p2 B
qq 1  q2 p2  p1 P2
2
Where,
P1 = Original Price
q1 = Original Quantity
P2 = New Price X
O Q1 Q2
q2 = New
Quantity Quantity 41
 Arc Elasticity of Demand
Find Elasticity of Radios Between:

P1 = Rs. 500 q1 = 100

P2 = Rs. 400 q2 = 150

Elasticity =
q1  q2 p1


- 50 900
Ep 250
p 2
100
= q1 
Ep = -1.8
q2 p1  1
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 Total Expenditure (Outlay) Method

This method was developed by Dr. Alfred

Marshall.

According to this method, To measure the

elasticity of demand, it is essential to know how
much & in what direction the total expenditure
has changed as a result of change in the price of a
good.

1
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 Total Expenditure (Outlay) Method
Elasticity of Change in Price Total
Demand Revenue
Greater than Price TR
unity (Ep > 1)

Decrease Price TR No Change

Unity (Ep = 1)
Increase Price No Change

Less than Price TR

unity (Ep < 1)
1
8
Total Expenditure (Outlay) Method
Y
T
A
R E>1

B
N

E=1

M C

P E<1

X
O E D
Total 45
 Income Elasticity of Demand

Income elasticity of demand is the degree

of responsiveness of quantity demanded of a
good to a small change in the income of
consumer.

% Change in Quantity Demanded

Ey =
% Change in Income
2
0
 Degrees of Income Elasticity

Positive Income Elasticity of Demand (Ey > 0)

Unitary Income Elasticity (Ey = 1)
Less than Unitary Income Elasticity
(0<Ey < 1)
More than Unitary Income Elasticity (Ey
> 1)

Negative Income Elasticity of Demand (Ey < 0)

Zero Income Elasticity of Demand (Ey = 0)
2
1
Positive Income Elasticity of Demand
Income elasticity of Y
demand for a good is
positive, when with DY
an increase in the A
income of consumer,
his demand for the B
Good Increases and
vice versa.
It is positive in case of DY

normal goods. O Q Q X

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Quantity
 Negative Income Elasticity
• Income elasticity of
Y
demand is negative
when increase in the
DY
income of the
consumer is 20

accompanied by fall in 15
demand of a good
10
•It is negative in case
DY
of
Inferior which Giffen 5

Goods are
O 1 2 3 4 X
known as
Goods. Quantity 50
 Zero Income Elasticity of Demand
Y
• Income elasticity of DY
demand is zero, When
change in the income of
consumer evokes no
20 B
change in his demand.
15

10 A
• Demand for
necessaries like oil, 5

salt, etc., have zero DY

X
O
income elasticity of 1 2 3 4 5

demand. Quantity 51
 Cross Elasticity of Demand
Cross elasticity of demand is a change in the demand of one
good in response to a change in the price of another good.

q py
=
E c 
py x
qx
Where, Ec = Cross Elasticity
qx = Original Q.D. of X
∆qx = Change in Q.D. of X py
= Original Price of Y
∆py = Change in Price of Y
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 Types of Cross Elasticity

1.PositiveCross elasticity
2.Negative Cross Elasticity
3.Zero Cross Elasticity

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Positive Cross Elasticity of Demand
Y
• It is positive in case of
Substitute Goods.
DS
• For example, Rise in
P1 E1 the Price of Coffee
will lead to Increase in
Demand for Tea.
P E
• The Curve slopes
DS
Upward from Left to
Q Q1
Right.
O X

Quantity of T ea 53
 Negative Cross Elasticity of Demand
• It is negative in case of Y
complementary goods.
• E.g. Rise in price of DC
Bread will bring down
E1
the demand of Butter. P1

The curve slopes

downwards from left
E
to right. P

DC

O Q1 Q X

Quantity of
Butter54
 Zero Cross Elasticity of Demand

Zero cross elasticity of demand: Cross elasticity of

demand is zero when two goods are not related to each other.

For example,
Rise in the price of wheat will have no effect
on the demand for shoes.

2
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 Relationship between Ep, MR & TR
The relationship between “MR, Ep & TR” can be
summarized as follows.
Where Ep = 1, MR = 0
TR does not changes with change in price

Where Ep < 1, MR < 0

TR decreased with decreased in price and Vice Versa

Where Ep > 1, MR > 0

TR decreased with increase in price and increases with
decrease in price
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Graphically

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 Importance of Elasticity
 In business decision making
→ Product pricing
→ Pricing of input
→ Pricing of point products
→ Demand forecasting

 Determination of various government policies

→ Determination of terms of trade
→ Determination of tariff policy
→ Determination of the policy of devaluation

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 Determination of international trade policies:
→ Tax policies
→ Policies of granting protection
→ Explain the paradox of poverty
“Price and Income”

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 Numerical
* Suppose that your demand Schedule for compact discs is as
follows:
Price Quantity Demanded Quantity Demanded
(Income=Rs.$10,000) (Income=Rs.$12,000)

$8 40 50

10 32 40

12 24 30

14 16 20

16 4 12
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Calculate:
Price elasticity of demand when price of compact disc
increases from $8 to $10 if
(I) your income is $10,000 and
(II) your income is $12,000.

Income elasticity of demand when your income increases

from $10,000 to $12,000 if
(i) if price is $12 and
(ii) price is $16.

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THE END

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