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DEMAND – ELASTICITY
The law of demand studies the inverse relationship between demand and price at low
price demand will be more and at high price demand is low. It tells us only the direction of
change in price and quantity of demand. The concept of elasticity of demand is one of the
original contribution of Dr. Marshall. He studied the concept of elasticity of demand only
with reference to price changes. But income & cross elasticity of demand fall outside the
scope of his study.
Difference between law of demand and principles of elasticity of demand brings clear
understanding of elasticity of demand. The law demand tells only the direction of change in
price and quantity demanded, but the concepts of demand elasticity clearly explain how much
change are happened in demand due to changes in price. The expression “how much is
important” this indicated the concept of elasticity of demand is basically a question of
measurement.
Dr. A. F. Marshall defines “The elasticity of demand in a market is great or small according
to the amount demanded increases much or little for a given fall in the price, and diminishes
much or little for a given rise in price”
From the above definition, it is clear elasticity of demand is primarily related to extension or
contraction of demand for a fall or rise in price. Hence it is referred to as price elasticity of
demand.
Price elasticity of demand is one of the important concepts of elasticity which is used to
describe the effects of change in price on quantity demanded. The measure of relative
responsiveness of quantity demand to price along a given demand curve is known as price
elasticity of demand (PED). Marshall had given a clear formulation of price elasticity as the
ratio of a relative change in quantity to a relative change in price.
(Or)
E(d) = Q / P
Price elasticity of demand in the ratio of proportionate change in the quantity demand of a
given commodity to a proportionate change in its price.
= [▲ Q / Q ] / [▲ P / P]
Therefore E (Pd) = [▲ Q / Q] [P / ▲ P]
Generally the co-efficient of price elasticity of demand holds a negative sign, because there is
an inverse relation between the price and quantity demanded.
The elasticity of demand = 80 / -20 = - 4, for sake of convenience we ignore the negative
sign and take into account only the numerical value of the elasticity. Elasticity of demand is
linked to law of demand and demand curve is always negatively sloped downward; hence the
sign of elasticity will also be negative. For studying the negative will be ignored.
D D
Price
O Q X
Quantity
2). Perfectly inelastic demand :- In this case what ever may be the change in price, the
quantity demanded will be remain the same, mean that there will constant demand.
It means elasticity of demand is Zero (0), Price elasticity of demand curve is vertical
straight line parallel to Y– aces. It indicates Zero (0) inelastic.
d
P
Price
O Q X
Quantity
When price increases from op to op1 the quantity demand is remain same, elasticity is “Zero”
3). Unitary elasticity of demand: If a proportionate change in price exactly brings about the
same proportionate change in demand. It means elasticity of demand is “one” - 1. The
demand curve is rectangular hyperbole.
Y D
Price
P1 D
O q1 X
q Quantity
When price falls to OP to OP1, quantity demanded increases form OQ to OQ1,. Thus a
change in price has resulted in an equal change in the quantity demanded. So price elasticity
of demand is equal to Unity.
4). Relatively elasticity of demand: If a proportionate change in price brings about a more
than proportionate change in demand. It mean elasticity of demand is more than one (>1).
The demand curve is represented by a gradually sloping demand curve.
Ex: Change in price 25%, demand will be 50% = 50/25 = 2 >1
Y D
P
P1
Price D
O Q Q1 X
Quantity
When price falls from op to op1 the amount demanded increases form oq to oq1, a small
change is the price leads to a higher increase in the demand.
5). Relatively inelasticity of demand: If a proportionate change in price brings about a less
than proportionate change in demand. It mean elasticity of demand is less than one (<1). The
demand curve is represented by a gradually sloping demand curve.
Ex: Change in price 50%, Demand will be 25%: 25/50 = 0.5 <1
Y D
P
P1
Price
D
O Q Q1 X
Quantity
When price falls from op to op1 the amount demanded increases form oq to oq1, a large
change is the price leads to a smaller increase in the demand.
For practical purpose, it is not enough to know whether the demand is elastic or inelastic. It is
more useful to find out what exact the demand is elastic or inelastic. There are different
methods to measure the price elasticity of demand and among them the following 3 methods
are generally used.
1). Total Expenditure or Out lay method
2). Point method
3). Arc method
This method is given by Alfred Marshall. Under this method the total expenditure of a
commodity will be compared. In this method elasticity can be measured by comparing the
total expenditure on the commodity before and after change in price.
The measurement of 3 types of elasticity may be seen the following table and figure
(Demand schedule showing elasticity greater, unit and less than unit)
In the above table between S. No 1 and 2 cases the demand is elastic. Because when price fall
1.50 to 1.25, the demand increases from 3 to 4 units. We can see conversely also S.no 2 and 1
Y D
1.50
1.25
Price D
O 4.50 5.00 X
Total outlay
In the above chart and table represents, when price falls the total outlay increases. Therefore
elasticity of demand is grater than unity.
In the above table between S.No. 2 and 3 cases the demand is unitary. As price falls, the
quantity demand increases, but the total outlay remains constant at Rs. 1.20, Hence elasticity
of demand is inelastic
Y
D
1.25
Price
1.00
O 5.00 X
Total outlay
When price falls from Rs. 1.25 to 1.00 the total outlay is same i.e Rs. 5.00. Therefore
elasticity of demand is inelastic.
Y D
0.75
0.60
Price
0.40
D
O X
4 4.20 4.50
Total outlay
Here the total outlay is declining even though quantity demanded is increasing. Hence
demand is said to be inelastic. It is coefficient is less than one.
We can summarize the total outlay method as follows. In the above table as
price falls demand increases, but the total outlay remains constant at Rs. 5/-, hence elasticity
of demand is equal to unity. In case of demand for 3units and 4 units at the price of Rs. 1.50/-
and 1.25/- the total outlay increases from 4.50/- to 5.00/-. Therefore elasticity of demand is
greater than unity. In case of s.no 4, 5, &6 the outlay is declining even though quantity
demand is increasing (6,7,&8 units) and the total outlay is decreasing Rs.4.50/-,4.20,& 4.00.
Hence demand is said to be inelastic and elasticity is coefficients is less than one.
The relationship between total outlay and elasticity of demand my be shown
diagrammatically.
Price ≥1
=1
≤1
O X
Total outlay
2). Point Method (or) Geometrical Method:
Point method is exact method to measure elasticity. Alfred Marshal takes a straight line
demand curve intercepted by both the axes and measures price elasticity at any point on the
demand curve.
We can explain the point method with following table and diagram
POINTS PRICE QUANTITY
(Rs) (Units)
A 6.00 40
B 3.00 90
Y
A D
Upper segment
P
D
Lower segment
O Quantity B X
In the straight line, demand curve is extended to meet the two axis. Point “ P” divides the
demand curve into two segments. Point elasticity at point “P” is calculated by the ratio of
lower segment of the curve below the given point to upper segment point.
That is demand elasticity at Point “P” = Lower segment Area / Upper segment Area
= PB / PA
= [OQ1 – OQ ] / OQ
[OP1 – OP] / OP
Hence the Price elasticity by point Method = Lower segment of the demand curve =L
Upper segment of the demand curve U
A
P2
Price P
P1
O X
Quantity (demand) B
3) Arc Method:-
When price and quantity changes are large, then we measure elasticity over an arc of the
demand curve rather than at any specific point on it. The formula for measuring is different
from that of the point method.
Instead of taking the old and new prices and quantities, the average of both is taken in this
method. Thus Arc elasticity is called as average elasticity.
Any two points of the demand curve make an arc. An arc is a curved line of the selection (or)
segment of a demand curve.
Q1 – Q2 ÷ P1 – P2 = Q/ (Q1+Q2) ÷ P / (P1+P2)
Q1+Q2 P1 + P2
Q1= Old demand Q2= New demand P1= Old price P2= New price
Example = P1 = 10 , P2 = 15; Q1 = 200 Kg. , Q2 = 100 Kg.
D
Y
P2 – 15 a
P
b
Price P1 – 10 D
Q
O 100 200
Demand X
4000
Income 3000
2000
1000
D
1 2 3 4
Quantity
Income is one of the elements that impacts on the demand for a commodity. Income
Elasticity Demand may be defined as the ration (or) proportionate change in the quantity
demand of a commodity to a given proportionate change in income. In short, it indicates the
extent to which demand changes with a variation in consumers income.
Depends upon changes in Income and changes in demand we can classify the income
elasticity of demand into the following types.
Perfectly Income Elasticity Demand:- A small change in Income of the consumer will
causes an infinite increase in the quantity demand. Infinite
Perfectly Income Inelasticity Demand:- In this case whatever may be the changes in the
Income of a consumer, quantity demanded will remain perfectly constant. Zero
Unitary Income Elasticity:- The proportionate change in Income exactly bring about the
same proportionate change in demand. One
Zero E≥1
Income
O X
Quantity
Cross demand refers to the quantity of commodity A purchased by the consumers at various
prices of commodity of B. There is a close relationship between goods. They are either
substitutes or complements.
D D
P2 P2
P1 P1
Price of Price of
Tea D Bread D
O Q1 Q2 X O Q1 Q2 X
Demand for coffee Demand for Butter& Jam
According to Point Watson “Cross elasticity of demand is the rate of change in quantity
associated with a change in the price of related goods”.
If A and B products demand are in the same direction those goods are called substitutes. If
both are in different direction they are complement product.
Cross Elasticity of demand is positive in case of good substitutes... High cross elasticity of
demand exists for those commodities, which are close substitutes.
If A B are perfectly substitute products the Cross elasticity will be infinite.
If A B are not perfectly substitute product the Cross elasticity demand is zero.