UNIT II

ELASTICITY OF DEMAND

Is the effect of change in demand determinants the same on change in Quantity demanded?

Elasticity of Demand helps in providing a Quantitative value for the responsiveness of Quantity demanded to change in each of the determinants in the demand function. Marshall introduced the concept of Elasticity of demand.

Elasticity of Demand defined

Elasticity of Demand is defined as the percentage change in Quantity Demanded caused by a percentage increase in the demand determinant under consideration, while other determinants are held constant.

% change in Quantity Demanded of Good X

Ed = % change in determinant Z Q/ Q = Z/ Z = Z Q * Q Z

The larger the value of elasticity, the more responsive is Quantity Demanded to changes in the determinant under consideration. Types of Elasticity of Demand: Price elasticity of demand Income elasticity of demand Cross elasticity of demand Advertising elasticity of demand

PRICE ELASTICITY OF DEMAND

Price elasticity of demand measures changes in quantity demand to a change in Price. It is the ratio of percentage change in quantity demanded to a percentage change in price.

Proportionate change in Quantity demanded of commodity X

Edp =
Proportionate change in price of commodity X

 Q/ Q1 = P/ P1 =

Q * P

P1 Q1

TYPES OF PRICE ELASTICITY

Perfectly Elastic Perfectly Inelastic Unit Elasticity Relatively Elastic Relatively Inelastic

PERFECTLY ELASTIC
No change in price is required to cause a change in Quantity Demanded i.e., When any Quantity can be sold at a given price, and when there is no need to reduce the price, the demand is said to be perfectly elastic.

E=

PERFECTLY INELASTIC
When a change in price, however large, causes no change in Quantity Demanded demand is said to be perfectly inelastic.
E= 0

UNIT ELASTICITY
When a given proportionate change in price causes an equal proportionate change in Quantity Demanded, then the demand is said to be Unit Elastic
E=1

RELATIVELY ELASTIC
When a change in price causes a more proportionate change in Quantity Demanded, then the demand is said to be relatively elastic.
E >1

RELATIVELY INELASTIC
When a change in price causes a less than proportionate change in Quantity Demanded, then the demand is said to be relatively inelastic.
E<1

DETERMINANTS OF PRICE ELASTICITY OF DEMAND

The number and closeness of substitutes The share of commodity in buyers budget Nature of the commodity Number of uses a commodity can be put to Habit forming characteristic Time period.

INCOME ELASTICITY OF DEMAND

Income elasticity of Demand for a commodity shows the extent to which a consumers demand for the commodity changes as a result of a change in his income.
Proportionate change in Quantity demanded of commodity X Edi = Proportionate change in income of consumer Q/ Q1 = I/ I1 = I Q * Q1 I1

 Income elasticity of demand is positive for all normal goods. In the case of inferior goods, demand for the good varies inversely with income.

TYPES OF INCOME ELASTICITY

Unitary Income Elasticity High Income Elasticity Low Income Elasticity Zero Income Elasticity Negative Income Elasticity

CROSS ELASTICITY OF DEMAND

Cross Elasticity of Demand is defined as the ratio of percentage change in demand for one good to percentage change in the price of some other related good. This is because of the fact that the two goods may be either substitutes or complements to each other.

ADVERITISING ELASTICITY OF DEMAND

It measures the response of Quantity Demanded to change in expenditure on Advertising and other sales promotion activities.

FACTORS INFLUENCING ADVERTISING ELASTICITY OF DEMAND

Stage of Product Market Effect of Advertising in terms of time Influence of Advertising by rivals

SIGNIFICANCE OF ELASTICITY OF DEMAND

Level of Output and price Fixation of Rewards for factors of production Government policies
Public Utilities Taxation Policy Fixation of Rate of Exchange

Demand Forecasting

ELASTICITY MEASUREMENT
There are two kinds of Elasticity Measurement: 1. Point Elasticity 2. Arc Elasticity

POINT ELASTICITY
Point Elasticity of Demand relates to the elasticity at a particular point on the demand curve.

Point Elasticity, Ep = Q/ Q
Z/ Z

Q
* Z

Z
Q

ARC ELASTICITY
The elasticity between two separate points of Demand curve is called Arc Elasticity. Arc Elasticity, Ep = Q * P1+P2

Q1+Q2

PROBLEM 1
Find Price Elasticity of Demand at Rs. 7, when price and Quantity Demanded behave in the following manner:

Price(p) : 9 8 7 6 5 4 3 2 1 Qd (kg) : 5 15 20 30 36 45 55 70 90

PROBLEM 2
If a consumers demand for a commodity increases from 100 units per week to 200 units per week when his income rises from Rs.2,000 to Rs.3,000, find his income elasticity of demand.

PROBLEM 3
The price of coffee increases from Rs.50 per kg to Rs.70 per kg and as a result the demand for tea increases from 5 kg to 10 kg. What is the cross elasticity of tea for coffee?

What is a forecast???
A forecast is a prediction or estimation of a future situation, under given conditions.

Need for Demand Forecasting

Demand is uncertain Production decisions Supply decisions Expectations of future growth Decisions on various types of expenditures

FACTORS GOVERNING DEMAND FORECASTING

o o o o o o o o o Functional Nature of Demand Types of forecasts Forecasting level Degree of Orientation Established or New products Nature of Goods Degree of Competition Market Demand Other factors

DEMAND FORECASTING TECHNIQUES

Non- Statistical Techniques Statistical Techniques

DEMAND FORECASTING
NON STATISTICAL METHODS Complete Enumeration Survey Sample Method STATISTICAL METHODS

Sales force Opinion Method

Expert Opinion Method Delphi Technique / GD

Test Marketing
Controlled Experiments Judgemental Approach

DEMAND FORECASTING
NON STATISTICAL METHODS STATISTICAL METHODS

Mechanical Extrapolation / Trend Projection Methods

Barometric Techniques
Correlation and Regression Methods Simultaneous Equations Method

Mechanical Extrapolation / Trend Projection Methods

Fitting Trend Line by Observation

Mechanical Extrapolation / Trend Projection Methods

Fitting Trend Line by Observation Time Series Analysis using Least Squares Method

Time Series Analysis using Least Squares Method

Sales = a + b (year number) i.e., S = a + b . T Where, a and b are constants determined using S = Na + b t St = a t + b t^2
Where, N = No. of years for which data is available

PROBLEM 1
YEAR SALES (Rs. in lakhs) 1992 75 1994 84 1996 92 1998 98 2000 88

Estimate the sales for the years 2002 and 2004.

PROBLEM 2
The following data refers to sales, in thousands of rupees of a certain product during 5 years.
YEAR SALES 1993 605 1994 1995 1996 1997 715 830 790 835

Assuming the present trend continues, in which year will you expect 1994 sales to be doubled?

Mechanical Extrapolation / Trend Projection Methods

Fitting Trend Line by Observation Time Series Analysis using Least Squares Method Moving Average Method

Moving Average Method

This method considers that the average of past events determine the future events. The average keeps on moving depending up on the number of years selected.

PROBLEM 1
Calculate 3-day moving average from the following daily sales data. Date and month Jan 1 Jan 2 Jan 3 Jan 4 Jan 5 Daily sales (lakhs) 40 44 48 45 53

Mechanical Extrapolation / Trend Projection Methods

Fitting Trend Line by Observation Time Series Analysis using Least Squares Method

Moving Average Method

Exponential Smoothing

Exponential Smoothing
This method determines values by computing exponentially weighted system. The weights assigned to each value reflect the degree of importance of that value. Smoothened Value = w (current observed value) + (1-w) (previous smoothened value)

BAROMETRIC TECHNIQUES It is based on the presumption that relationship can exist among various economic time series.

There are three kinds of relationships. 1. Leading series 2. Coincident series 3. Lagging series

Correlation and Regression Methods

Correlation describes the degree of association between two variables. When two variables tend to change together, then they are said to be correlated. The extent to which they are correlated is measured by correlation coefficient.

A statistical measure that attempts to determine the strength of the relationship between one dependent variable (usually denoted by Y) and a series of other changing variables (known as independent variables).

The two basic types of regression are linear regression and multiple regression. Linear regression uses one independent variable to explain and/or predict the outcome of Y, while multiple regression uses two or more independent variables to predict the outcome.

The general form of each type of regression is: Linear Regression: Y = a + bX + u Multiple Regression: Y = a + b1X1 + b2X2 + B3X3 + ... + BtXt + u Where: Y= the variable that we are trying to predict X= the variable that we are using to predict Y a= the intercept b= the slope u= the regression residual. In multiple regression the separate variables are differentiated by using subscripted numbers.

Simultaneous Equations Method

All variables are simultaneously considered, with the conviction that every variable influences the other variables in an economic environment. It is a system of n equations with n unknowns.