Dr. SHEELA YADAV

Assistant profrssor

Department of Economics

M.R.M. CoLLEGE, Darbhanga

CONCEPT OF ELASTICITY

‘Elasticity' is a standard measure of the degree of sensitivity ( or responsiveness) of one variable to changes in another variable.

Is a measure of the responsiveness of the quantity demanded of a good to a change in an exogenous variable.

The elasticity of demand measures the responsiveness of the quantity demanded of a good, to change in its price, price of other goods and changes in consumer’s income.

TYPES OF ELASTICITY DEMAND• Price elasticity of demand –

Price elasticity of demand is a measurementof percentage change in quantity demandeddue to percentage change in own price of thecommodity.

• Income elasticity of demand –

The income elasticity of demand is ameasurement of percentage change inquantity demanded due to percentagechange in consumer’s income.

• Cross elasticity of demand –The cross elasticity of demand measures howmuch the quantity demanded of one goodresponds to change in the price of anothergood.

di E income in %

demandedquantity in %

dc E

price in %

demandedquantity in %Edp

Ycommodity of price in %

Xcommodity of demandedquantity in %

MEASUREMENT OF PRICE

ELASTICITY OF DEMANDTotal expenditure method–

This method finds out howmuch and in what directiontotal expenditure changes asa result of change in theprice of a commodity.

When demand is elastic, anegative relationship existsbetween changes in price andchanges in total expenditure.

When demand is unit-elastic,changes in price does not effecton total expenditure.

When demand is inelastic, apositive relationship existsbetween changes in price andtotal expenditure.

Total expenditure paid by a consumer

= Price x Quantity (P x Q)

= Total revenue received by a producer

TOTAL EXPENDITURE METHOD Situation Price of the

commodity

(Rs)

Quantity

( kg)

Total

expenditur

e (Rs)

Effect on

Total

Expenditure

Elasticity

of

Demand

A 2

1

4

8

8

8

Same Total

Expenditure Ed= 1

B 2

1

4

10

8

10

Total

expenditure

increases

Ed> 1

C 2

1

3

4

6

4

Total

expenditure

decreases

Ed< 1

TOTAL EXPENDITURE METHOD

Area (NBAR) shows inverse relationship between price and total expenditure .It is a situation when : Ed >1

Area (PDCM) shows positive relationship between price and total expenditure. It is a situation when : Ed <1

Area(MNBC) shows total expenditure as constant in response to increase or decrease in price .It is a situation when : Ed=1

GEOMETRIC METHOD

Geometric method –This method measures elasticity of demand at different points on the demand curve .Its also called ‘point method’ of measuring elasticity of demand

R is mid- point of demand curve

At point R, Ed =1

At point D, Ed =∞

At point D’ Ed = 0

At point S, Ed > 1

At point S, Ed <1Lower segment from mid point(R) of demand curve

Upper segment from mid point(R) of demand curve

PROPORTIONATE OR

PERCENTAGE METHOD Under this method,

elasticity of demand is

measured by the ratio of

the percentage change in

quantity demanded to

percentage change in

price.

Example

Price of commodity X= Rs.5,

Decrease in price of X = Rs. 4,

Quantity demanded =4 units,

Increase in quantity demanded =6 units,

Δp = 4-5= -1

ΔQ=6-4=2

ED= (-) 2∕-1× 5∕4 =10∕4=2.5Q

P

P

Q

P

P

Q

QED

DEGREE OF PRICE ELASTICITY OF

DEMANDPerfectly Inelastic

Demand

The demand curve isvertical, the quantitydemanded is totallyunresponsive to the price.Changes in price have noeffect on consumer demand.

Slope of a vertical straightline Demand = ∞

According , Ed at any point

on DD=(1/∞) x (P/Q)=0

PERFECTLY ELASTIC DEMAND

The demand curve ishorizontal, any change in pricewill cause consumers to changetheir consumption pattern. Theslightest increase in priceresults in correspondingdecrease in demand.

The slope of a horizontalstraight line = 0

Accordingly, at any point inEd curve DD

= (1/0) X (P/Q)=∞

UNITARY ELASTIC DEMAND

Percentage change in

quantity demanded is equal

to the percentage change in

price

Demand curve is rectangular

hyperbola. At any point on

this demand curve Ed = 1.

Because total expenditure

remains constant in response

to increase or decrease in

price of the commodity.

Thus, Ed = 1

LESS THAN UNITARY ELASTIC

DEMAND Demand is inelastic if the

percentage change in quantity isless than the percentage change inprice.

When price increases from OP0 to OP1, Quantity demanded decreases OQ0 to OQ1 relatively less.

Total expenditure on the commodity increases in the inelastic region on demand curve.

Ed < 1

GREATER THAN UNITARY ELASTIC

DEMAND The percentage change in quantity

demanded is greater than the

percentage change in price.

Total expenditure and price is

inversely related in the elastic

region of the demand curve.

Ed > 1

CROSS ELASTICITY OF DEMAND

Substitutes goods:

cross elasticity of demand is positive.

when PB DB and DA(substitute of B) thus, PBand DA are positively related.

Complements goods:

cross elasticity of demand is negative.

when PB B and A (complement of B) thus, PBand D A are negatively related.

.

INCOME ELASTICITY OF DEMAND

This measures how much thequantity demanded of a goodresponds to a change inconsumer’s income. Assumingthe price of good is constant.

A good is a normal good if income elasticity > 0.

A good is an inferior good if income elasticity < 0.

A good is a luxury good if income elasticity > 1.

A good is a necessity good if income elasticity < 1.

FACTORS DETERMINING PRICE

ELASTICITY OF DEMAND Nature of commodities: necessities-inelastic, Luxuries-elastic

Variety of uses: If commodity has a variety of uses, more elasticdemand.

Number and closeness of substitutes: More the substitutes, moreelasticity.

Income level: Richer people are less affected by price rise.

Proportion of income spent on commodity: Where it is small, lessthe elasticity.

Urgency of Demand: The more urgent the demand, the less elastic.

Durability of a commodity: The more durable and reparable acommodity, higher the elasticity.

Time: Demand for a product is more price elastic in the longer runby when the consumer gets the time to make the shift.

Habit of consumer: Goods to which a person becomes habitual willhave Inelastic Demand

IMPORTANCE OF THE ELASTICITY

OF DEMAND Pricing Decisions of Business Firms - If demand for commodity of a business firm, is

elastic then the firm will not increase the price of the commodity as the total revenuedecreases and vice-versa.

Price regulation of Agricultural products-(Paradox) - When production ofagriculture increases, then total revenue decreases and vice-versa, because of theinelastic nature of demand for agricultural products.

Importance in International Trade. - If demand for export is inelastic thendevaluation will not be gainful. The benefit of devaluation are obtained only when thedemand for export is elastic.

Importance in Wage Determination -If demand for labor is inelastic then the wagesgiven are higher.

Price discrimination - Higher prices are determined for segments with inelasticdemand and lower prices are determined for segments with inelastic demand

Government’s tax policy - Goods with inelastic demand has higher tax rates.