2. Introduction
– There is relationship between demand and price –
Law of Demand
– It indicates the direction of change of quantity
demanded to change in price.
– But it does not give the answer to how much or to
what extent?
– This information is given by Elasticity of Demand.
3. Elasticity of Demand
– It is defined as degree of responsiveness of quantity
demanded of a good to changes in one of the
variables .
» Price
» Consumers Income
» Prices of related goods
4. Price Elasticity of Demand
• It is defined as ratio of the percentage change in quantity
demanded of a commodity to percentage change in price.
ep =
% change in QD
% change in Price
• The price elasticity are expressed with a +ve sign even if
they are inversely related as we want to measure the
“magnitude of responsiveness”.
5. Price Elasticity of Demand
ep =
ep =
% change in QD
% change in Price
Change in Quantity * 100
Original Quantity
Change in Price * 100
Original Price
ep =
•
•
∆q * p
q
∆p
It has a negative sign
The price elasticity are expressed with a positive sign even if
they are inversely related as we want to measure the
magnitude of responsiveness.
6. Numerical
Q 1. The price of a Chocolate Bar in the local newsagent rises
from 25p to 30p. As a result, the newsagent finds that the
demand for this product falls from 80 bars a day to 40 bars
a day. Find the price elasticity of demand.
(-2.5)
Q2. The price of a litre of unleaded petrol rises from Rs 80 to
Rs 84 . As a result, the quantity demanded at a local
station falls from 4000 to 3880 litres a day. What is the
price elasticity of demand?
(-0.6)
Notice:
The answer is negative. This is because the price rose
(+ve) causing the quantity demanded to fall (-ve).
The demand curve is nearly always downward sloping
showing a negative relationship between price and quantity
demanded
7. Q A company decides to increase the price of
Brand X drink from Rs2 a bottle to Rs2.10 a
bottle. The price elasticity of demand for Brand
X is 0.8. He currently sells 300 bottles a day.
What will the new demand be (ceteris paribus)?
Ans 288
8. Three Concept of
Demand Elasticity
1.
Price Elasticity:
Degree of responsiveness to change in its price
2.
Income Elasticity:
Sensitiveness of quantity demanded to change in income.
3.
Cross Elasticity:
Degree of responsiveness to change in the price of a
related good (Substitute /Complement).
9. Types of Price Elasticity
The value of ep varies from Zero (0) to Infinity ( ∞ )
Elastic Demand:
Inelastic Demand:
When the percentage
change in quantity
demanded is greater than
percentage change in price.
When the percentage
change in quantity
demanded is less than
percentage change in price.
D
D
P
P
P’
D
P’
D
O
M
M’
O
M
M’
10. Types of Price Elasticity
•
There are 5 types of price elasticity
•
The main reason for differences in elasticity is the
possibility of substitution i.e
presence or absence of competing products.
1)
Perfectly Elastic or ep = ∞
When demand is infinite or
unlimited at given price.
A reduction in price causes the
quantity to increase from
zero to infinite.
11. Types of Price Elasticity
2)
Perfectly Inelastic or ep = 0
When change in prices have
a zero impact on the
quantity demanded
3) Unitary Elastic Demand or ep = 1
When change in quantity
demanded is equal to
the change in price.
12. Types of Price Elasticity
4)
Relatively Elastic or ep > 1
When change in quantity
demanded is greater
than change in prices
5) Relatively Inelastic or ep < 1
When change in quantity
demanded is less
than the change in price.
14. Determinants of Price
Elasticity
•
The Availability of Substitutes
– The number and kind of substitute makes the consumer
sensitive to change in prices.
– If close substitute are available, its demand is elastic.
– If no close substitute are not available, even with rise in
price the demand is inelastic.
• The proportion of Consumer Income spent
– Greater the proportion of income spent o the commodity,
greater the elasticity of demand.
• The number of uses of a commodity
– The greater the number of uses to which a commodity
can be put, the greater will be its price elasticity of
demand.
15. Determinants of Price
Elasticity
•
Complementarity between Goods
– Complementarily or joint demand for goods effects
the elasticity
– Consumers are less sensitive to change in prices of
goods that are complementary with each other.
• Time and Elasticity
– Demand is more elastic if the time involved is long, as
consumers can substitute goods in the long run.
– Demand is inelastic in the short run.
• Durability of the commodity
18. 1) Percentage Method:
It is defined as ratio of the percentage change in quantity
demanded of a commodity to percentage change in price.
ep =
ep =
% change in QD
% change in Price
Change in Quantity * 100
Original Quantity
Change in Price * 100
Original Price
ep =
∆q * p
∆p
q
19. Numerical
Q. If the price of the commodity falls from Rs 6 to
Rs 4 per unit and due to it QD increases from
80 units to 120 units.
Find out the price elasticity of demand?
Ans: 1.5
Q. If the price of the commodity rises from Rs 4 to
Rs 6 per unit , the QD falls from 120 to 80 units.
What is the price elasticity of demand?
Ans: 0.60
20. 2) Midpoint / ARC Method:
–
–
–
Which price and quantity to use while calculating the %
change.
When the changes in price and quantity are
substantially large.
In this method we take the midpoint of the initial and
final values of price and quantity as a base.
ep =
( q2-q1)
q1 + q2
2
ep =
p2 - p1
p1 + p2
2
∆q * p1 + p2
∆p q1 + q2
21. • What is the point, after all, of a firm knowing the
elasticity of demand for the product he sells?
If he can assess what the change in his sales will
be for a given change in the price of his product,
and then he can work out the change in his
revenue.
P
P* Q = TR
D
Q
22. 3) Total Revenue Method
– Total revenue is the amount received by the
seller from the sale of the quantity of the
good sold in the market.
– Total Revenue: P * Q
23. Numerical
Q. Suppose a seller of a textile cloth wants to lower the price
of its cloth from Rs 150 per metre to Rs 142.5 per metre.
If its present sales are 2000 metres per month and further
estimated that its elasticity of demand for the product
equals -0.7. show
a) Whether or not total revenue will increase as a result
of his decision to lower the price.
Ans: 2070
b) Calculate the exact magnitude of its new total revenue.
Ans: Rs 2,94,975
(With reduction in price his total revenue has decreased)
24. 1.
Demand is elastic ( ep >1)
The % increase in quantity demanded of the commodity
will be greater than the % fall in price.
Total Revenue will increase.
Conversely a rise in price reduces Total revenue.
P
R
R’
P’
Q
Q’
For Example:
A vegetable seller decides to cut the price of his potatoes
from Rs 40/Kg to Rs 32p/Kg. The ep for this product is 2.
He currently sells 80 Kg of potatoes a day. How many will he
sell after the price cut?
25. But what will happen to his revenue?
Revenue before the price cut: Rs 40 × 80Kg = Rs3200
Revenue after the price cut: Rs32 × 112Kg = Rs3584
The price cut causes revenue to increase.
The rise in demand as a result of the price cut was
proportionately higher than the fall in price
'gain' box is larger than the 'loss' box,
so the seller's total revenue has increased
26. b) What will happen if he increase the price to Rs 44 / kg
Revenue before the price increase:= 40p × 80 = Rs3200
Revenue after the price increase: = 44 × 64 = Rs 2816
27. 2.
Demand is Inelastic (ep<1)
A fall in price reduces total revenue
A rise in price raises total revenue
A rise in price will lead to a percentage decline in
quantity demanded that is proportionately less than the
rise in price.
R
P’
R’
P
Q
Q’
For example:
Petrol has a relatively inelastic demand. If value of the
elasticity is 0.5, the initial price is 80p per litre and sales of
4000 litres per day.
28. a) What happens when the price is cut to Rs 72 per litre. The
cut in the price will lead to an increase in less demand. The
new demand will be 4200 litres.
Revenue before the price cut:= 80 × 4000 litres = 3200
Revenue after the price cut: = 72 × 4200 litres = 3024
• There is a fall in total revenue where the 'loss' box is much
bigger than the 'gain' box.
29. • For example:
b) Increase in the price to 88p per litre. This 10% rise in the
price will lead to a fall in demand, but by only 5%. The new
demand will be 3800 litres.
Revenue before the price cut: = 80 × 4000 litres = Rs 3200
Revenue after the price rise: = 88p × 3800 litres = Rs 3344
• This rise in total revenue , where the 'gain' box is much
bigger than the 'loss' box.
30. 3. Demand is Unit elastic ( ep = 1)
The percentage increase in quantity demanded of the
commodity will be equal to the percentage fall in price.
Total Revenue will be same.
P
R
P’
R’
Q
Q’
31. Elasticity and Revenue
P
Qd
TR
P *Q
(ep)
5.00
30
150
-
4.75
40
190
e >1
4.50
50
225
e >1
4.25
60
255
e >1
4.00
75
300
e >1
3.75
80
300
e =1
3.50
84
294
e <1
3.25
87
282.75
e <1
33. Numerical
Q1. Price of the good falls from Rs 10 to Rs 8 per unit. As a
result, its quantity demanded increases from Rs 80 units
to 100 units. Find out the elasticity of the goods.
Ans: ep=1
Q2. If the price of commodity rises from Rs 15 to Rs 16 per
unit. As a result the QD falls from Rs 100 to 80 units.
Find out ep is more than one or less than one?
Ans: ep> 1
Q3. The ep for petrol is equal to unity and at Rs 15/litre an
individual demand 80 litre of petrol in a week. How much
price of petrol should be fixed so that he demands 60 litres
of petrol?
Ans: 60 Litre
34. Importance for Business
Decision Making
• Pricing of Public Utilities:
Charging higher prices for high end consumers/ lower prices
to the low end consumers.
• International Trade:
Charge a higher export prices if the demand for exports is
inelastic, charge lower prices and earn higher revenue.
• Product differentiation and Differential pricing:
Company to produce different products and charge different
prices depending on the elastic or inelastic demand.
• Shifting the Taxation:
Shifting the taxation depends upon the elasticity of demand.
35. Cross Elasticity of Demand
• The degree of responsiveness of demand for one good in
response to the change in prices of another good.
• Good X and Good Y are substitute of each other
P1
P
P2
M2
M
Good 1
X
Q1 Q2
Good Y
What would have happen if Good X & Y were
complement Goods?
36. Cross Elasticity of Demand
ec =
Percentage change in Qd of X
Percentage change in the price of good Y
ec = Qx2 – Qx1
Qx2 + Qx1
2
Py2 – Py1
Py2 + Py1
2
37. Substitute and Complementary
Goods
• Positive Cross Elasticity:
– Rise in price of good X leads to rise in demand of
good Y
– They are substitute goods
• Negative Cross Elasticity:
– Rise in price of good X leads to fall in demand of good Y
– They are Complementary goods
• Zero Cross Elasticity:
– Rise in price of good X will have no effect on good Y
– They are unrelated goods
38. Importance for Business Decision
Making
• It helps in formulating pricing strategy for multi-product
firms.
• It defines the boundaries of an Industry
( Anyone company cannot raise the price of the product
without losing sales to the other firm)
39. Numerical
Q.
Colgate sells its standard size toothpaste for Rs 25. Its sales
have been on an average 8000 units per month over the
past year. Recently, its close competitor Binaca reduced the
price of its same standard size toothpaste from Rs 35 to
Rs30. As a result colgate sales declined by 1500 per units
per month.
1) Calculate the cross elasticity between the two products.
2) What does it indicate about the relationship between the
two.
40. Income Elasticity
• It shows the degree of responsiveness of quantity
demanded of a good to a small change in the income of
consumers.
• Income Elasticity = % change in purchase of a good
% change Income
ei = q2 – q1
q2 + q1
2
y2 – y1
y2 + y1
2
41. Income Elasticity and Goods
Zero Income Elasticity :
Rise in Income does not lead to increase in quantity demanded
(Unresponsive to change)
Positive Income Elasticity:
Rise in Income leads to rise in quantity demanded
( Luxury / Normal goods)
Negative Income Elasticity:
Rise in income leads to fall in quantity demanded
( Necessity /Inferior Goods)
Income Elasticity is Unity:
Proportion of income spent on the good remain the same a
consumers income increases.
42. Importance for Business Firms
• The firms which are producing goods which have high
income elasticity have a great potential for growth.
– The firms will be located in those areas which are
growing
– The marketing strategies will be targeted to those
segment whose income is increasing.
• Demand for products which have low income elasticity
will be not be greatly effected by economic fluctuations.
( Recession proof)
