UNIT-2 ELASTICITY OF DEMAND
Elasticity of demand can be defined as the degree of responsiveness of quantity demand to a given change in price or other related factors of demand. On the other words if represent the rate of change in the quantity demanded due to the change in price on other related factors.
Change in quantity quantity demand vs price of the goods or services.
Change in quantity demand vs income of the customers etc.
TYPES OF ELASTICITY:The elasticity of demand can be categorized into four heads:1.
Price elasticity of demand.
2.
Income elasticity of demand.
3.
Cross elasticity of demand.
4.
Advertising elasticity of demand.
1.
PRICE ELASTICITY OF DEMAND:It refers to the quantity demand of a commodity in response to a given change in
price. Price elasticity is also called as negative or inverse where customer uses to purchase the product when price falls. Price elasticity of demand=proportionate demand=proportionate change in the quantity demand of product (X) Proportionate change in the price of (X) Or (Q 2-Q 1)/Q 1 Edp =------------------(P2-P1)/P1 Where Q 1=quantity demanded before change Q 2=quantity demanded after change P1=price of the goods/services before change P2=price of the goods/services after change
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PROBLEM: - Suppose Q 1=5000units Q 2=7500units P1=Rs500 P2=Rs450 From this determine the price elasticity? Sol:-from the above problem, we can easily conclude that (7500-5000)/5000 Edp =---------------------------(450-500)/500 =-5 Or -5= 50% increase on quantity demanded when the price falls at 10%. Therefore it is the inverse in nature, of null be +5. Therefore, e>1 and it can called as price elasticity of demand.
PROBLEM: - Suppose Q 1=5000units Q 2=5500units P1=Rs500 P2=Rs350 From this determine the price elasticity? Sol:-from the above problem, we can easily conclude that (5500-5000)/5000 Edp =--------------------------(350-500)/500 =-0.33 Here 30% reduction in price tends to 10% increase in demand. As it is inverse in nature, the price elasticity may be 0.33 but it is less 1 Or e<1 Therefore it is called as inelasticity of demand.
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PROBLEM: - Suppose Q 1=5000units Q 2=7500units P1=Rs500 P2=Rs750 From this determine the price elasticity? Sol:-from the above problem, we can easily conclude that (7500-5000)/5000 Edp =--------------------------(750-500)/500 =-1 As it is inverse in nature, the price may be 1 but it is equal to 1. Or e=1 Therefore it is called as unitary elasticity of demand.
2.
INCOME ELASTICITY OF DEMAND:It refers to the quantity demand of a commodity in response to a given change in
income of a customer. Income elasticity of demand=proportionate demand=proportionate change in the quantity demand of product (X) Proportionate change in income (X) Or (Q 2-Q 1)/Q 1 Edi =------------------(I2-I1)/I1 Positive income elasticity indicates that the demand for a product rises quickly than the rise in income.
TYPES OF INCOME ELASTICITY:A. ZERO INCOME ELASTICITY: Here a change in income will have no effect on the quantities. Ex:-SALT B. NEGATIVE INCOME ELASTICITY: An increase in income may lead to a reduction in the quantities demanded. Such goods are called interior goods. Ex:-Biris to cyorates. 3
C. POSITIVE INCOME ELASTICITY:An increase in income may lead to an increase in the quantities demanded. Such goods as superior goods. Ex:-Silver ornaments to gold articles.
3.
CROSS ELASTICITY OF DEMAND:Cross elasticity of demand refers to the quantities demanded of a commodity to
response to change in price of related rel ated goods, which may be substitute/complement. Cross elasticity of demand=proportionate change in the quantity demand of product (X) Proportionate change in price of product (X) Or (Q 2-Q 1)/Q 1 Edc =------------------(P2y-P1y)/P1y Where Q 1=quantity demanded before change. Q 2=quantity demanded after change. P1y=price of related goods before change. P2y=price of related goods after change. EX:-Tea and coffee – positive (substitute) Tea and sugar – negative (complement)
4 ADVERTISING ELASTICITY OF DEMAND:It refers to increase in the sales revenue because of change in the advertisement expenditure. Income elasticity of demand=proportionate change in the quantity demand of product (X) Proportionate change in income (X) Or (Q 2-Q 1)/Q 1 EdA =------------------(A2-A1)/A1 Where Q 1=quantity demanded before change. Q 2=quantity demanded after change. P1=price of the goods/services before change. P2=price of the goods/services after change. 4
SIGNIFICANCE OF ELASTICITY OF DEMAND:-
The quantities demanded of each product as service are signifying with various factors as follows:1.
Production process depends on price.
2.
Fixation of price on products/services.
3.
Government policies on price.
4.
Forecasting or anticipation of demand.
5.
Planning the levels of output and prices.
1.
PRODUCTION PROCESS DEPENDS ON PRICE:In every production process land, labor, capital, building rent and technology are
the prime factors. Therefore cost of product may be varying on the cost of each factor. EX:-Demand of land in village is elastic, where demand of land in industrial area is inelastic.
2.
FIXATION OF PRICE ON PRODUCTS/SERVICES:Based on competition of market. The manufacture has to demand the price of a
product. Therefore the manufacture can decide the amount of price that can be fixed for his product based on the concept of price If there is no competition in the market a monopoly of price should be fix. On the other hand, when competition is there price may be fixing as per the convenience of customers.
3.
GONVERMENT POLICIS ON PRICE:Government is always deciding the taxes on various products as per the
consumption of need of people. Therefore government is fi xed/deciding various taxes on essential products with marginal reductions e.g. food products, kerosene, etc. on the other hand it is imposing huge taxes on indigenous goods such as petrol, gas, diesel etc. in every budget government wants to increase their funds through bank deposits by the increasing of interest rates. Government uses the concept of elasticity in fixing charges for the public utilities such as electricity tariff, water charges, ticket for in rail, road or air services.
4.
FORECAST OR ANTICIPATION OF DEMAND:Basically income can easily determine the quantity demanded by the customers
or service through their income level. Here the traders can estimate the quantity of goods to be sold at different income levels to realize the targeted revenue.
5. PLANNING THE LEVELS OF OUTPUT AND PRICE:The elasticity is very essential for producers,. Here the producers can estimate whether the change in price will bring in adequate revenue or not. In general for items whose demand is elastic, it would benefit him to charge relatively low prices. On the other hand , if the demand for the product is inelastic, a little or higher price may be helpful to him to get huge profits without losing sales. 5
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