ELASTICITY

OF
DEMAND
 Elasticity
Elasticity measures the sensitivity one variable
to another.
For decision making it is very important to
know how much will demand change when
any of the factors that affect demand change.
 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.
 Kinds Of Price Elasticity Of Demand
1) Perfectly elastic demand
2) Relatively elastic demand
3) Elasticity of demand equal to utility
4) Relatively inelastic demand
5) Perfectly inelastic demand
 Perfectly elastic demand

y
When the
Perfectly elastic
P demand curve demand for a
R product changes
I
D
increases or
D
C decreases even
E when there is no
change in price,
it is known as
perfect elastic
0 x
demand.
 Relatively elastic demand
y
When the
P Relatively elastic proportionate
R demand curve
D
change in
I
demand is more
C
than the
E
proportionate
D
changes in price,
it is known as
0 x
relatively elastic
demand
demand.
 Unit Elasticity of demand

When the
y
D
proportionate
P
change in
R
demand is equal
I Unit elasticity
to proportionate
C
changes in price,
E
D
it is known as
unitary elastic
0 demand
x demand
Relatively inelastic demand
Y
D When the
Relatively inelastic
demand curve
proportionate
change in demand
P
is less than the
R proportionate
I changes in price, it
C is known as
relatively inelastic
E
demand
D

O X
demand
Perfectly inelastic demand
Y
D
When a change in
price, howsoever
Perfectly inelastic
P demand curve large, change no
R
changes in quality
demand, it is known
I
as perfectly inelastic
C demand
E

0 D X
demand
Measurement Of Price Elasticity Of
Demand
There are main methods like
1. Percentage method or proportionate
method
2. Total outlay method or total revenue
method
3. Geometric method or point method
4. Arc elasticity of demand
 1. Percentage method

The price elasticity of demand is measured by

its coefficient Ep.
This coefficient Ep measures the percentage
change in the quantity of a commodity
demanded resulting from a given percentage
change in its price
 2. Total outlay method or total
revenue method
Prof. Marshall
Total outlay = Price *Quantity Demanded
 3. Point elasticity

Price elasticity of demand measured at a point

(P,Q) on the demand curve
PE= Upper Segment/ Lower segment
Used for forecasting demand
 4. Arc Elasticity of Demand
It is calculated over a range of prices.
Instead of choosing either the initial of final
price and quantity, use the average of the two
prices and quantities.
Used when changes in the price are not small.
Elasticity = q1-q2/ q1+q2* p1+p2/p1-p2
 Factors Affecting Price Elasticity Of
Demand
Nature of the Commodity
Availability of Substitutes
Variety of uses of commodity
Postponement
Influence of habits
Proportion of Income spent on a commodity
Range of prices
Practical Importance of the Concept
of Price Elasticity Of Demand
Taking Business Decisions
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
 Income Elasticity Of Demand

Proportionate change in Demand

Income Elasticity Of Demand =
Proportionate change in Income
i.e.
q y
Income Elasticity Of Demand = +
Q Y
 Measurement Of Income Elasticity Of
Demand
Here , q = Change in the quantity demanded.
Q = Original quantity demanded.
y = Change in income.
Y = Original income.
For e.g. ,when Income of the consumer =
2,500/- , he purchases 20 units of X, when
income = 3,000/- he purchases 25 units of X
 Importance Of the Concept of Income
Elasticity Of Demand
In production planning and management
In forecasting demand when change in
consumers income is expected
In classifying goods as normal and inferior
In expansion and contraction of the firm
 Cross Elasticity of Demand

Express a relationship between the change in

the demand for a given product in response
to a change in the price of some other
product
E.g. if the X tea demand reduces
tremendously than it effect could be seen in
demand of sugar and milk.
 Measurement Cross Elasticity of
Demand
Proportionate change in Demand
for product X
Cross Elasticity of Demand =
Proportionate change in Price of
i.e. product Y

Cross Elasticity of Demand = qx p y

+
Qx Py
 Cross Elasticity of Demand For
Y Substitutes
D
Price of Y

O X
Demand for Y
 Cross Elasticity of Demand For
Y Complementary Products
D
Price of Y

D
O X
Demand for Y
Cross Elasticity of Demand For Neutral
Y Products
D
Price of Y

O X
Demand for Y
 Importance of Cross Elasticity Of
Demand
In demand forecasting
Helps in measuring interdependence of price
of commodity .
Multiproduct firms use these concept to
measure the effect of change in price of one
product on the demand of their other product
 Elasticity of Supply
Es= Percentage change in quantity supplied/
Percentage change in price