ELASTICITY OF DEMAND

 

   

   ELASTICITY OF DEMAND
MICRO ECONOMICS/BUSINESS ECONOMICS/CA/CMA/CS FOUNDATION

   DR SHASHI AGGARWAL

   MEANING
 OF ELASTICITY OF DEMAND

   LAW OF DEMAND STATES THAT THERE IS AN INVERSE REALTIONSHIP BETWEEN THE PRICE AND QUNATITY DEMANDED OF A COMMODITY.THE LAW OF DEMAND EXPLAINS  DIRECTION OF CHANGE IN DEMAND FOR A COMMODITY AS A RESULT OF CHANGE IN PRICE.

   THE LAW OF DEMAND DOES NOT EXPLAIN THE DEGREE OF CHANGE .IT IS QUALITATIVE STATEMENT

   IN ORDER TO MEASURE THE QUANTITY PROF MARSHALL DEVELOPED THE CONCEPT OF ELASTICITY OF DEMAND IN HIS FAMOUS BOOK ,” PRINCIPLES OF ECONOMICS

   J.S MILL AND COURNOT WERE THE EARLY ECONOMISTS WHO REFERRED TO ELASTICITY OF DEMAND

 

   ELASTICITY OF DEMAND MEASURES THE CHANGES IN DEMAND  OF A COMMODITY IN RESPONSE TO A CHANGE IN THE PRICE OF THE COMMODITY ,OR CHANGE IN THE INCOME OF THE CONSUMER OR CHANGE IN THE PRICE OF RELATED GOODS.

   DOOLEY,THE ELASTICITY OF DEMAND MEASURES THE RESPOSNIVENESS OF THE QUANITY DEMANDED OF A GOOD TO CHANGE IN PRICE,PRICE OF OTHER GOODS AND CHANGES IN CONSUMER’S INCOME.

   DR. MARSHALL,” ELASTICITY OF DEMAND MAY BE DEFINED AS THE PERCENTAGE CHANGE IN THE QUANTITY DEMANDED DIVIDED BY THE PERCENTAGE CHANGE IN THE PRICE.

   TYPES OF ELASITICTY OF DEMAND

   PRICE ELASTICITY OF DEMAND:PRICE ELASTICITY OF DEMAND IS THE RATIO OF PERCENTAGE CHANGE IN THE QUANITY DEMANDED OF A COMMODITY TO PERCENTAGE CHANGE IN ITS PRICE.

   E=(-) (PERCENTAGE CHANGE IN QUANTITY DEMANDED)(PERCENTAGE CHANGE IN PRICE)

   INCOME ELASTICITY OF DEMAND: OTHER THINGS SUCH AS THE PRICE OF THE GIVEN COMMODITY,PRICE OF RELATED GOODS,TASTE OF THE CONSUMER ETC REMAINING CONSTANT ,PERCENTATGE CHANGES IN INCOME OF THE CONSUMER IS CALLED INCOME ELASTICITY OF DEMAND

   EY = PROPORTIONATE CHANGE IN QUANTITY DEMANDED/PROPORTIONATE CHANGE IN PRICE

 

   CROSS ELASTICITY OF DEMAND: CROSS ELASTICITY OF DEMAND IS A MEASURE OF CHANGE IN THE QUANTITY DEMANDED OF GOODS Y AS CHANGE IN THE PRICE OF GOODS X

   EC= PROPORTIONATE CHANGE IN QUANTITY DEMANDED OF Y/PROPORTIONATE CHANGE IN PRICE X

 

   PRICE ELASTICITY OF DEMAND

  PRICE ELASTICITY OF DEMAND IS THE RATIO OF THE PERCENTAGE CHANGE IN THE QUANTITY DEMANDED OF A COMMODITY TO PERCENTAGE CHANGE IN ITS PRICE

  PRICE ELASTICITY OF DEMAND DENOTES THE RATIO AT WHICH THE DEMAND CONTRACTS WITH RISE IN PRICE AND EXTENDS WITH FALL IN PRICE

  DR. MARSHALL,” ELASTICITY OF DEMAND MAY BE DEFINED AS THE PRICE CHANGE IN THE QUANTITY DEMANDED DIVIDED BY THE PERCENTAGE CHANGE IN THE PRICE

 

   THERE IS INVERSE RELATIONSHIP BETWEEN PRICE AND QUANITY DEMANDED OF A GOOD.

   PRICE ELASTICITY OF DEMAND IS EXPRESSED BY MINUS (-SIGN)

   E= (-) PERCENTAGE CHANGE IN QUANITY DEMANDED/PERCENTAGE CHANGE IN PRICE

   SUPPOSE THERE IS FALL IN PRICE BY 5% IS FOLLOWED BY EXTENSION IN DEMAND BY 15%. . FALL IN DEMAND IS INDICATED BY MINUS SIGN. ON MULTIPLICATION THESE MINUS  SIGN TURN TO PLUS

   E= -(15%)/-5%=3

 

 

   DEGREES OF PRICE ELASTICITY OF DEMAND

   PRICE ELASTICITY OF DEMAND OF ALL GOODS OR OF ONE GOOD AT DIFFERENT PRICES IS NOT ALWAYS MAY BE MORE OR IT MAY BE LESS

   ACCRDING TO MARSHALL,” THE ELASTICTY OF ( OR RESPONSIVENESS OF DEMAND IS GREAT OR SMALL ACCORDING TO THE AMOUNT DEMANDED INCREASES MUCH OR LITTLE FOR GIVEN FALL IN PRICE AND DIMINISHES MUCH OR LITTLE FOR A GIVEN RISE IN PRICE.

1.       PERFECTLY ELASTIC

2.       PERFECTLY INELASTIC

3.       UNIT ELASTIC

4.       MORE THAN UNIT ELASTIC

5.       LESS THAN UNIT ELASTIC

   PERFECTLY ELASTIC DEMAND

   A PERFECTLY ELASTIC DEMAND IS ONE IN WHICH LITTLE CHANGE IN PRICE WILL CAUSE AN INFINITE CHANGE IN DEMAND. IN THIS CASE,A VERY LITTLE RISE IN PRICE CAUSES THE DEMAND FOR FALL TO ZERO AND A VERY LITTLE FALL IN PRICES CAUSES THE DEMAND TO EXTEND TO INFINITY.

   PERFECTLY INELASTIC DEMAND

   A PERFECTLY INELASTIC IS ONE IN WHICH A CHANGE IN PRICE PRODUCES NO CHANGE IN THE QUANTITY DEMANDED

   UNIT ELASTIC DEMAND

   UNITARY ELASTIC DEMAND:- UNITARY ELASTICITY OF DEMAND IS ONE IN WHICH A PERCENTAGE CHANGE IN PRICE PRODUCE EQUAL PERCENTAGE CHANGES IN DEMAND

   SHAPE IS RECTANGULAR

   HYPERBOLA

   GREATER THAN UNITARY ELASTIC OR ELASTIC DEMAND

  GREATER THAN UNITARY ELASTIC DEMAND IS ONE IN WHICH A GIVEN PERCENTAGE CHANGE IN PRICE PRODUCES RELATIVELY MORE PERCENTAGE CHANGE IN DEMAND. IF 5 % FALL IN PRICE CAUSE 20% EXTENSION IN DEMAND.

  (-20%)/5%=4

   LESS THAN UNITARY ELASTIC

   LESS THAN UNITARY ELASTIC DEMAND IS ONE IN WHICH A GIVEN PERCENTAGE CHANGE IN PRICE PRODUCES RELATIVELY LESS PERCENTAGE CHANGE IN DEMAND.

 

   DEGREES OF ELASTICITY

   PRICE ELASTICITY

  DENOTES RATIO AT WHICH THE DEMAND CONTRACTS WITH A RISE IN PRICE AND EXTENDS WITH A FALL IN PRICE. THERE IS AN INVERSE RELATIONSHIP BETWEEN PRICE AND THE QUANITY DEMANDED OF A GOOD

  PRICE ELASTICITY IS EXPRESSED AS MINUS SIGN

  E=(-) PERCENTAGE CHANGE IN QUANITY DEMANDED/PERCENTAGE CHANGE IN PRICE

   METHODS OF MEASUREMENT OF PRICE ELASTICITY OF DEMAND

1.       TOTAL EXPENDITURE METHOD

2.       PROPORTIONATE METHOD

3.       POINT ELASTICITY METHOD

4.       ARC ELASTICITY METHOD

5.       REVENUE METHOD

   TOTAL EXPENDITURE METHOD

  ALSO KNOWN AS UNITY METHOD. EVOLVED BY DR . MARSHALL

  IN ORDER TO MEASURE THE ELASTICITY OF DEMAND:

•               HOW MUCH AND

•               IN WHAT DIRECTION THE TOAL EXPENDITURE HAS CHANGED AS A RESULT OF CHANGE IN THE PRICE OF THE GOODS

§TOTAL EXPENDITURE = PRICE X QUANITY

   TOTAL EXPENITURE METHOD

§THERE ARE THREE MEASURES OF ELASTICITY OF DEMAND.

1.       GREATER THAN UNITY:- WHEN TOTAL EXPENDITURE INCREASES WITH FALL IN PRICE AND DECREASES IN RISE IN PRICE. ELASTICITY IS GREATER THAN ONE

2.       EQUAL TO UNITY :- WHEN THERE IS NO CHANGE IN TOTAL EXPENDITURE

3.       LESS THAN UNITY :-WHEN TOTAL EXPENDITURE DECREASES WITH FALL IN PRICE AND RISE WITH RISE IN PRICE.

 

   TOTAL EXPENDITURE METHOD

   TOTAL EXPENDITURE METHOD

   TOTAL EXPENDITURE DIAGRAM

   

 

   PROPORTIONATE METHOD/PERCENTAGE
METHOD/OR FLUX METHOD

   IT WAS GIVEN BY DR. FLUX. ALSO KNOWN AS FLUX’S METHOD. ALSO KNOWN AS MATHEMATICS METHOD.

   P_E = (-) (% CHANGE IN QUANTITY DEMANDED)/% CHANGE IN PRICE OR

   P_E =(-)( ΔQ/ΔP) X P/Q

   PROPORTIONATE METHOD IS USED WHEN CHANGE IN PRICES AND CONSEQUENT CHANGES IN DEMAND ARE VERY SMALL

 

 

 

 

   EXAMPLE

   PRICE OF ICE CREAM = RS 2

   DEMAND IS  FOUR

   WHEN PRICE OF ICE CREAM RISE TO 4 THEN DEMAND FALLS TO 1

    P=2, Q=4 P₁=4   Q₁ = 1

   ∆P= P₁-P=4-2=-2

   ∆Q= Q₁-Q=1-4=-3

   E_D= -(P/Q X∆Q/∆P)

   = -(2/4) X-3/2)=3/4 WHICH IS LESS THAN ONE 

 

   EXAMPLE

   PRICE OF ICE CREAM = RS 4

   DEMAND IS ONE UNIT

   WHEN PRICE OF ICE CREAM FALLS TO 2 DEMAND EXTENDS TO 4

    P=4

   Q=1

   P₁=2

   Q₁ = 4

   ∆P= P₁-P=2-4=-2

   ∆Q= Q₁-Q=4-1=3

   E_D= -(P/Q X∆Q/∆P)

   = -(4/1X3/-2) =6 WHEN E >1

    

 

   REVISED FORMULA

   MAIN DEFECT OF MEASURING PRICE ELASTICITY IS THAT WE INTERCHANGE THE VALUES OF INITIAL PRICE AND NEW PRICE,DIFFERENCE IN ELASTICITY.

   REVISED FORMULA

   E=(-) (P_m/Qm) x(∆Q/∆P)

   THE MEASUREMENT OF PRICE ELASTICITY OF DEMAND BY PROPORTIONATE METHOD AND BY TOAL OUTLAY METHOD WILL BE IDENTICAL

 

   POINT METHOD

   GIVEN BY DR MARSHALL. IT IS USED TO FIND OUT THE ELASTICITY OF DEMAND AT A PARTICULAR POINT ON A DEMAND CURVE. ALSO KNOWN AS GEOMETRICAL METHOD. IT IS USED TO MEASURE INFINITELY SMALL CHANGES IN PRICE AND DEMAND ON PARTICULAR PRICE.

   E = LOWER SECTOR OF DEMAND CURVE/UPPER SECTOR OF DEMAND CURVE

   LOWER SECTOR IS GREATER THAN UPPER SECTOR THEN E >1

   LOWER SECTOR= UPPER SECTOR

   E=1

   LOWER SECTOR IS LESS THAN UPPER SECTOR THEN ELASTICITY IS LESS THAN ONE

   POINT METHOD

                                                                  

 

 

 

 

 

 

 

 

 E =PB/PA                              

 

             

   POINT METHOD

                 D                   A                             E= PB/PA

   ARC METHOD

   IT IS USEFUL WHERE CHANGES IN PRICE AND DEMAND ARE VERY LARGE. IT WAS GIVEN BY DALTON AND FURTHER DEVELOPED BY WATSON AND LERNER

   ACCORDING TO WATSON “ ARC ELASTICITY IS THE ELASTICITY AT THE MID POINT OF A DEMAND CURVE.

   LEFTWITCH : WHEN ELASTICITY IS  COMPUTED BETWEEN TWO SEPARATE POINTS ON A DEMAND CURVE THE CONCEPT IS CALLED ARC ELASTICITY

   E  =(Q₁-Q₂) /1/2(Q₁ +Q₂) X( P₁+ P₂)/1/2(P₁-P₂)

   =(Q₁-Q₂) /(Q₁ +Q₂) X( P₁+ P₂)/(P₁-P₂)

 

   E =( ΔQ/ΔP) X( P₁+ P₂)/( Q₁+Q₂)

 

 

   ARC ELASTICITY

   D

   REVENUE METHOD

 

   PRICE ELASTICITY OF DEMAND CAN BE ALSO MEASURED WITH THE HELP OF AVERAGE AND MARGINAL REVENUE

   E= A/(A-M)

   A= AVERAGE PRICE WHICH IS FOUND BY DIVIDING TOTAL REVENUE BY THE NUMBER OF UNITS SOLD

   A=PRICE PER UNIT AND IT IS ALSO CALLED DEMAND CURVE

   M= MR WHICH IS DEFINED AS THE CHANGES IN TR BY SELLING AN ADDITIONAL UNIT OF OUTPUT.