Elasticity of Demand

ByVenkateswarlu A

Overview of presentationIndividual demand and market demandElasticity of demandTypes of elasticity of demand

Price elasticity of demand Income elasticity of demand Cross-Price elasticity of demand

Methods to determine elasticityUsing elasticities in managerial decision making

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The demand for a commodity arises from the consumers’ willingness and ability to purchase the commodity

Demand

1 2 3 4 5 60

1

2

3

4

5

6

7

Pric

e (P

x)

Quantity Demanded (Qdx)

Individual Demand

dx

100 200 300 400 500 6000

1

2

3

4

5

6

7

DxPr

ice

(Px)

Quantity Demanded (Qdx)

Market Demand

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Elasticity of demand

It measures the responsiveness of consumer for a commodity to the changes in its determinants or forces.

Types of elasticity of demand:-Price elasticity of demandIncome elasticity of demandCross-Price elasticity of demand

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Price elasticity of demand

It measures the responsiveness (elasticity) in the quantity demanded of the commodity to a change in it’s price.

EP =

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Types of Price elasticity of demand

Perfectly inelastic demand

Relatively inelastic demand

Unit elastic demand

Relatively elastic demand

Perfectly elastic demand

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Perfectly inelastic demand

Dx

Pric

e (P

x)

Quantity Demanded (Qdx)X

Y

O

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Relatively inelastic demandPr

ice

(Px)

Quantity Demanded (Qdx)X

Y

p

p1

xx1O

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Unitary elastic demandPr

ice

(Px)

Quantity Demanded (Qdx)X

Y

p

p1

xx1O

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Relatively elastic demand

p

p1

xx1

Pric

e (P

x)

Quantity Demanded (Qdx)X

Y

O

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Perfectly elastic demandPr

ice

(Px)

Quantity Demanded (Qdx)X

Y

p

x x1O

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Price elasticity at various points

EP = B point= = -5

If |EP| > 1 then the demand curve is elastic|EP| = 1 then the demand curve is unitary elastic|EP|< 1 then the demand curve is inelastic

1

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6

Pric

e (P

x)

Quantity Demanded (Qdx)X

Y

O

A

B

C

F

G

HJ

100 200 400 500 600300

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Price elasticity at various points

A point= - 1() = ∞B point= -1 () = -5C point= -1 () = -2F point= -1 () = -1G point= -1 () = -1/2H point= -1 () = -1/5J point= -1 () = 0 1

2

3

4

5

6

Pric

e (P

x)

Quantity Demanded (Qdx)X

Y

O

A

B

C

F

G

H

J100 200 400 500 600300

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Point price elasticityThe responsiveness in the quantity demanded of a commodity could be measured by the inverse of the slope (is expressed in terms of the units of measurement.Note that the value of is given by a1, the estimated coefficient of P in regression equation.

EP = a1

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Point price elasticity determination

Qd = 19306 – 1606PFind the point price elasticity of demand if price is Rs.7Solution:

Qd =19306-1606(7) =8064

EP = a1

EP = -1606

EP = -1.39Gp No - 2 15May 1, 2023

Arc price elasticity

We use this method more frequently than point method to measure elasticity of demand between two points on the demand curve.

EP = x

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Arc price elasticity determination

Find the Arc price elasticity of demand between C and F points.Solution:

EP = x

EP = x

EP =

EP = -1.4Gp No - 2 17May 1, 2023

Income elasticity of demand

It measures the responsiveness (elasticity) in the quantity demanded of the commodity to a change in consumers’ income.

EP =

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Types of income elasticity of demand

Perfectly income inelastic demand

Relatively income inelastic demand

Unitary income elastic demand

Relatively income elastic demand

Perfectly income elastic demand

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Perfectly income inelastic demand

Dx

Inco

me

(I)

Quantity Demanded (Qdx)X

Y

O

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Relatively income inelastic demand

Inco

me

Quantity Demanded (Qdx)X

Y

y

y1

x x1O

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Unitary income elastic demandIn

com

e

Quantity Demanded (Qdx)X

Y

y

y1

x x1O

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Relatively income elastic demand

y

y1

x x1

Inco

me

Quantity Demanded (Qdx)X

Y

O

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Negative income elastic demandIn

com

e

Quantity Demanded (Qdx)X

Y

y

xx1O

y1

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Point income elasticity

Note that the value of is given by ai, the estimated coefficient of I in regression equation.

EI = ai

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Point income elasticity determination

Find the point income elasticity of demand if I=1.76, Qd =10312 and coefficient of I in regression equation is 947. Solution:

EI = ai

EI = 947

EI = 0.16Gp No - 2 26May 1, 2023

Arc income elasticity

This uses the average of the original and new incomes, and the average of the original and new quantities.

EI = x

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Arc price elasticity determination

Demand function for automobile industry is Qd=40000+5(I). If income of a consumer raises from 8000 to 9000 and sales from 70000 to 80000 then what is the Arc price elasticity of demand.Solution:

EI = x

EI = x

EI = 10 x 0.1133 EI = 1.133

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Cross-Price elasticity of demand

It measures the responsiveness in the demand for commodity X to change in the price of commodity Y. This is given by the percentage change in the demand for commodity X divided by the percentage in the price of commodity Y, holding constant all the other variables in the demand function.

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Exy =

Point cross-price elasticity

Note that the value of is given by aS, the estimated coefficient of Py.

Exy = as

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Arc cross-price elasticity

Point cross-price elasticity of demand gives different results, depending on whether the price of the related commodity(Py) rises or falls. To avoid this, we usually measure the Exy with following formula

EP = x

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Arc cross-price elasticity determination

Calculate the Exy if Py increases from Rs 50 to 100 and Qx increases from 125 to 150 units by using Arc price elasticity of demand.Solution:

Exy = x

EXY = x

EXY = 0.5 x 0.5454 EXY = 0.27

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Features of Cross-Price elasticity

If the value of EXY is positive, commodities X and Y are substitutes

If the value of EXY is negative , commodities X and Y are complementary

If the value of EXY is close to zero, X and Y are independent commodities

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Using elasticities in decision making

The firm can estimate the elasticity of demand with respect to all the forces or variables that affect the demand for the commodity that the firm sells. The firm needs these elasticity estimates in order to determine the optimal operational policies and the most effective way to respond to the policies of competing firms.

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Thank YouAny Questions?