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Elasticity of Demand

Topic 3

exercises

Rajesh used to get Rs. 5000 as pocket money


which increased to Rs. 7,000. he started going
more for movies but less for eating in the nearby
dhaba. There were no changes in ticket fare or
dhaba food prices? Do you think both the goods
are normal for Rajesh?
Which determinant of demand is at work in the
following cases?
1. Demand for bus service between Delhi and Agra
when the train service between the same cities
becomes cheaper.
2. News that petrol prices are going to be doubled.
3. Demand for land in an area where the govt is
going to establish a huge steel plant.

Contd..
What happens to the demand when
following changes occur?
Price of normal good falls
Income increases and the commodity
is normal
Income increases and the commodity
is inferior
Price of substitute good increases
Price of complement good falls.

Introduction
So far we have learnt how different factors
qualitatively affect the demand for a particular
commodity and the direction of change in quantity
demanded with respect to other factors.
But many times a knowledge about only the
direction of change is not sufficient. The
measurement or quantity of change also should be
known.
Elasticity of demand helps in quantitative
measurement of a change in demand due to
change in any of the factors influencing the
demand such as price, income of consumer or a
price of related good.

Price elasticity of demand


It measures the response of quantity
demanded to a change in its own price.
It is defined as a % change in quantity
demanded of a commodity divided by
% change in its price, holding other
variables in the demand function
constant.
Ep =

change in Q X P
change in P
Q
where P and Q are
original price and quantity respectively.

Example
Renu used to consume 10 ice-creams a
month when the price of ice-cream was
Rs.12. Ice-cream has become more
expensive with Rs15 per piece. She now
consumes only 8 ice-creams. What is price
elasticity?(-0.8)
Arup was buying 20 CDs when the price
was Rs.200 per CD. Now the price has
come down to Rs.150 and he is buying 30
CDs. What is elasticity?(-2)

Elastic and inelastic demand


If the change is price of a commodity brings
about more than proportionate change is
quantity demanded, it is called elastic
demand. 10% rise in price leads to more
than 10% fall in demand. Elasticity of
demand is greater than 1 in this case.
If the change in price of a commodity brings
about less than proportionate change in
demand, it is inelastic demand. For example,
10 increase in price may bring about less
than 10 % fall in the quantity demanded.
Here the elasticity is between 0 and -1.

Factors Affecting Price Elasticity of


Demand
Availability of substitutes
If close substitutes are not available, a
consumer is likely to be too much dependent
on the product and hence the elasticity will
be low. Example essential goods.
Proportion of total expenditure spent on
product
If the proportion is large, demand will be
sensitive to price change and elasticity will
be high

Factors Affecting Price Elasticity


of Demand
Time period of adjustment
Greater the time span, higher is the elasticity
for the same product. A substitute can be
explored in the long run. Oil price rise of
1970s is the best example. The demand for
oil was highly inelastic at that time. But over
time other forms of energy were explored.
Individuals habits
A product may be essential for someone but
not so for the others. Ex. Brown bread,
jogging shoes.

Income Elasticity
Income Elasticity of Demand:
The responsiveness of demand to changes
in incomes

Normal Good demand rises as


income rises and vice versa
Inferior Good demand falls as income
rises and vice versa
A positive sign denotes a normal good
A negative sign denotes an inferior good

formula
Income elasticity = Q x Y
Y
Q
Where Q and I refer to change in
quantity demanded and change in
income respectively.

Cross elasticity
The demand for a commodity also
depends upon the price of other
related goods. A measurement of
responsiveness in the demand for
commodity A to a change in the price
of B is called cross elasticity of
demand.
Cross elasticity = QA X PB
PB

QA

Class work

For each of the following, which


good will have more elastic
demand. Why?
1. Required textbook and mystery
novel
2. Biscuits and orange cream biscuits.
3. Electricity for next six months or
electricity next five years

Class work
Calculate price
elasticity of
demand for the
movement from A
to B
From C to A

Price

Quantity

1000

2000

3000

Income elasticity
Ey = Q/ I x I/Q
For the following
table, calculate
income elasticity of
demand for moving
from point A to
point B
From D to E

Income

Qd

8000

12000

10

16000

15

24000

20

28000

19

Applications (1)
Impact on Total Revenue

Elasticity
Price

Total revenue is price x


The importance of elasticity
quantity sold. In this
is the information it
example,
TRthe
= Rs5
x on
provides on
effect
100,000
=
Rs.500,000.
total revenue of changes in

price.
This value is represented by
the shaded rectangle.

Rs
5

Total Revenue

D
100

Quantity Demanded (000s)

Elasticity
Price

If the firm decides to


decrease price to (say)
Rs.3, the degree of price
elasticity of the demand
curve would determine the
extent of the increase in
demand and the change
therefore in total revenue.

Rs
5
Rs
3

Total Revenue

D
100

140

Quantity Demanded (000s)

Elasticity
Price (Rs)

Producer decides to lower price to attract sales

10

% Price = -50%
% Quantity Demanded = +20%
Ped = -0.4 (Inelastic)
Total Revenue would fall

Not a good move!


D
5 6
Quantity Demanded

Elasticity
Price (Rs)

10

Producer decides to reduce price to increase sales


% in Price = - 30%
% in Demand = + 300%
Ped = - 10 (Elastic)
Total Revenue rises
Good Move!

Quantity Demanded

20

Applications (2)
Economics of Agriculture
Bumper crop will generally lower the
income of farmers.
Increase in demand is slower (due to
low income elasticity ) than the
increase in supply (thanks to
technological progress) over years.
So govt. intervention in the form of say
crop restriction program