Demand Elasticity

Demand Elasticity

Law of demand indicates only direction of change in

quantity demanded in response to change in price.
 Elasticity of demand states with how much or to what extent
the quantity demanded will change in response to change in
any determinants.
“The elasticity (or responsiveness) of demand in a market is
great or small according as the amount demanded increases
much or little for a given fall in price, and diminishes much
or little for a given rise in price”.
 Elasticity
Elasticity is a percentage relationship between two
variables.

Measurement of the percentage change in one variable

relative to a percentage change in another variable.

Coefficient of elasticity = Percentage change in A

Percentage change in B
 Elasticity of Demand
According to the source of the change, the following
types of elasticity of demand can be stated:
Qd=f(P, Price of other, Income…..)
Price Elasticity of Demand
Cross Elasticity of Demand
Income Elasticity of Demand
Qs=f (P, weather condition,…..)
Elasticity of Demand
According to the degree of the change in the demand, the elasticity can be
classified in:
Perfectly Elastic
Relatively Elastic
Unitary Elasticity
Relatively Inelastic
Perfect Inelastic

Coefficient of elasticity (Price and Quantity of demand)

Percentage change in Price
Percentage change in Quantity of demand
 The extremes of the elasticity scale
Perfect elasticity:
There is only one possible price, and at that price an unlimited quantity
sold.
EP = ∞
 Perfect inelasticity:
The quantity demanded remains the same regardless of price.
EP = 0
 Categories of Elasticity
Unitary elasticity of demand: own price elasticity equal to 1

Relative Inelasticity of demand: own price elasticity less than 1 <

Relative elasticity of demand : own price elasticity greater than 1>

 Ranges of Elasticity
 The PED coefficients can vary from zero to infinity.

ED= 0 : Perfectly Inelastic =0 QD

ED < 1 : Inelastic P
ED = 1 : Unit Elastic
ED > 1 : Elastic
ED = ∞(Infinity) : Perfectly Elastic QD/P
Ranges of Elasticity
 Categories of Elasticity

0 1 2 3 4 5 6
 Price elasticity of demand

The change in the quantity demanded of a product due to a change

in its price is known as Price elasticity of demand.

Price elasticity of demand is the percentage change in quantity

demanded caused by a 1 percent change in price.

How sensitive is the quantity demanded to a change in the price of

the good.
Computing the Price Elasticity of Demand
The price elasticity of demand is computed as the percentage
change in the quantity demanded divided by the percentage
change in price.

The elasticity of demand

= Percentage change in quantity demanded QD
Percentage change in price P
Computing the Price Elasticity of Demand
Price Elasticity of Demand=
∆ Quantity ÷ ∆ price
Quantity Price
or
 % ∆ Quantity
% ∆ price
 Measurement of Price Elasticity
1. Arc Elasticity
Ep = (Q2 - Q1) ÷ (P2 - P1)
(Q1 + Q2)/2 [(P2 + P1) / 2]

Ep = Coefficient of arc price elasticity

Q1= Original quantity demand
Q2 = New quantity demanded
P1 = Original price
P2 = New price
Examples:
If the price of a product rises from Rs.11 to Rs.12, causing a fall in the
quantity demanded from 7 to 6.
Calculate price elasticity coefficient.

If the price of a product rises from Rs.10 to Rs.12, causing a fall in the
quantity demanded from 8 to 6.
Calculate price elasticity coefficient.
Hypothetical Demand Schedule
Price (Rs.) Quantity
18 0
17 1
16 2
15 3
14 4
13 5
12 6
11 7
10 8
Measurement of Price Elasticity
2.Point elasticity
Point elasticity (p)= dQ X P1
dP Q1

Calculate the point elasticity coefficient at Rs.12 and 6 units( Use

the above table data) .
= 1 x 12 =2
1 6
Factors Affecting Demand Elasticity
Nature of the Commodity (LP gas / Normal good/ goods)
Availability of Substitutes
Variety of uses of commodity
Postponement
Influence of habits
Proportion of Income spent on a commodity ( 100+0.80dY)
Practical Importance of the Concept of Price
Elasticity Of Demand
The concept is helpful in taking Business Decisions
Importance of the concept in formatting Tax Policy of the government
For determining the rewards of the Factors of Production
To determine the Terms of Trades Between the Two Countries
Determination of Rates of Foreign Exchange
For Nationalization of Certain Industries
Question 03
Consider the demand for a good. At price Rs 4, the
demand for the good is 25 units. Suppose price of the
good increases to Rs 5, and as a result, the demand for
the good falls to 20 units. Calculate the price elasticity?
Other Demand Elasticities
Income elasticity of demand measures how much the
quantity demanded of a good responds to a change in
consumers’ income.

It is computed as the percentage change in the quantity

demanded divided by the percentage change in income.
Income elasticity of demand
Income elasticity of demand
Types of Goods
Normal Goods- Positive
Inferior Goods- Negative
Higher income raises the quantity demanded for
normal goods but lowers the quantity demanded
for inferior goods
Income elasticity of demand
Goods consumers regard as necessities tend to be income
inelastic
Examples include food, fuel, clothing, utilities, and
medical services.
Goods consumers regard as luxuries tend to be income
elastic.
Examples include sports cars, furs, and expensive foods.
 iii. Cross elasticity of Demand
 Cross elasticity of demand is a measure of change in quantity
demanded of good-Y, as a result of change in the price of good –X.

 “The cross elasticity of demand is the proportional change in the

quantity of good –X demanded resulting from a given relative change
in the price of the related good-Y”.
(Ferguson)
 “ The cross elasticity of demand is a measure of the responsiveness of
purchases of the related good – Y”
(Leibhafsky)
 iii. Cross elasticity of Demand
 Measurement of Cross Elasticity of Demand

Cross elasticity of demand(Ec)

= Percentage change in Quantity demanded of good-X
Percentage change in the price of Good -Y
 Cross elasticity of Demand
Cross elasticity of demand can be of three types:

I. Substitute Goods
II. Complementary Goods
III. Unrelated Goods
 Cross elasticity of Demand

1. Substitute goods:

When the cross elasticity of demand for good X relative to the price of good Y is
positive, it means the goods X and Y are substitutes to each other. It implies that
in response to an increase in the price of good Y, the quantity demanded of good
X has increased as people start consuming product X as the price of good Y goes
up.
Example: Suppose a 20% increase in the price of tea results in an increase in
demand for coffee by 25%. This shows that the goods are substitutes for each
other.
Cross elasticity of Demand
 Cross elasticity of Demand
02. Cross-Price Elasticity of Complementary Products

Complementary products have the opposite effect. If the price of one

product increases, the demand for the complementary product decreases.
To consumers, the increased joint cost will force them to buy less.
i. Close Complements
In the case of a strong complement product, a minimal price decrease
leads to a large increase in demand for the complement product. The graph
below shows this impact.
 Cross elasticity of Demand
iii. Cross-Price Elasticity of Unrelated Products

Unrelated products do not affect one another. This means the cross-
effect elasticity is zero, and the graph would be represented by a vertical
line.
Elasticity of Supply
 Elasticity of Supply
The change in the quantity supplied of a product due
to a change in its price is known as Price elasticity of
supply.
The elasticity of supply, also known as price elasticity
of supply.
Measures the responsiveness of the quantity supplied
to a change in the price of a good, with all other
factors remaining the same.
Elasticity of Supply
Elasticity of Supply Formula
 Elasticity of Supply
Calculate the price-elasticity of the supply between point B and A for rise in
price.
 Practical Importance of the Concept of Price Elasticity Of supply

The concept is helpful in taking Business Decisions

Importance of the concept in formatting Tax Policy of the government

For determining the rewards of the Factors of Production

To determine the Terms of Trades Between the Two Countries