8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 1/21

Elasticity of Demand

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 2/21

elasticity of demand

Responsiveness of the demand for a good or serviceto the increase or decrease in its price. Normally,sales increase with drop in prices and decrease with

rise in prices. As a general rule, appliances, cars,confectionary and other non-essentials showelasticity of demand whereas most necessities (food,medicine, basic clothing) show inelasticity of demand(do not sell significantly more or less with changes inprice).

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 3/21

Pr ice Elastic Demand

D efinition: D emand is elastic if a change inprice leads to a bigger % change in demand;therefore the PE D will therefore be greaterthan 1.

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 4/21

1. They are luxury goods2. They are expensive and a big % of income e.g. sports cars and holidays3. Goods with many substitutes and a very competitive market. E.g. if

Simsbury s put up the price of its bread there are many alternatives, sopeople would be price sensitive

4. Bought frequently

Goods which are elastic, tend to have some or all of the following characteristics.

PED = % change in Q.D.% change in price

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 5/21

TY P ES OF PRIC E ELAST ICI TY

1. PERFECTLY ELASTICD EMAND .

2. PERFECTLY INELASTICD EMAND .

3. RELATIVE ELASTICD EMAND .4. RELATIVE INELASTICD EMAND .

5. UNITARY ELASTICD EMAND .

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 6/21

P e r fectly Elastic Demand

A good with a perfectly flatdemand curve has a priceelasticity of demand of infinity . This would meanthat a small change in pricewould lead to an infinitelylarge increase in D emand.In perfectly competitivemarkets (such as, say, coal),if you can charge slightly lessthan your competitors, and

still make a profit, you willfind your customers willattempt to buy as much asyou can produce.

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 7/21

P e r fectly Inelastic Demand

To have a situationwhere the D emandcurve is a vertical line isto think of a goodwhere a certainquantity is demanded,regardless of the price.Heroin would be theclosest ''real life''example of such a good.Addicts will payanything for their ''fix''.

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 8/21

R ELAT IV E ELAST IC DEMAND

If proportionatechange in quantitydemanded is greatthan the proportionatechange is price then,relatively elastic isgreater than 1. We canindicate it as EP>1.We can say a smallchange in price leadsto a big change inquantity demanded. Inthe case of increase or decrease we can saydemand is relativelyelastic.

E>1

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 9/21

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 10/21

Unit Elasticity Thetheory takes placewhen change indemand isproportionate to thechange in price. The

unit can be denotedas E=1

E=1

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 11/21

cross-price elasticity of demand

Proportionate change in the demand for one item in responseto a change in the price of another item. It is 'positive' wherethe two items are mutual substitutes, and any increase in theprice of one (say butter) will increase the demand for the

other (say margarine). It is 'negative' when the items arecomplementary and any increase in the price of one (say cars)will decrease the demand for the other (say tires). Also calledas Cr oss-elasticity of demand

.

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 12/21

Value of theelasticity

Price riseor cut? What will happen to the quantity demanded?

Will totalrevenue rise or

fall?

Ed = 0 Price rise The demand curve is vertical, so demand remains the same but

with a higher price.Rise

(Perfectlyinelastic) Price cut The demand curve is vertical, so demand remains the same but

with a lower price. Fall

0 < E d 1 Price riseThe demand curve is relatively steep, so the fall in demand will be

proportionately smaller than the rise in price. Rise

(Relativelyinelastic) Price cut The demand curve is relatively steep, so the rise in demand will be

proportionately smaller than the cut in price. Fall

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 13/21

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 14/21

1. Ratio Method :-

2. Total Outlay Method.= P*Q

3. Point Elasticity Method.

(The Geometric Method)

= ¨Q/Q X P/¨P

Measurements of Price Elasticity of Demand

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 15/21

1. Nature Of Commodity.

2. Availability of Substitutes.

3. Number Of Uses.4. Consumer s Income.

5. Height and Range of Price Change.

6. Proportion of Expenditure.

Factors Influenci ng El asticity of Demand

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 16/21

7 . D urability of the Commodity.

8. Habit and Custom.

9. Complementary Goods.10. Time.

11. Recurrence Of D emand.

12. Possibility of Postponement.

C ont«««

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 17/21

Income elasticity of demand.

Cross Elasticity of D emand.

Arc Elasticity of D emand.Promotional or Advertisement Elasticity of D emand.

Arc Advertisement Elasticity.

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 18/21

PR AC T IC AL APP LIC AT ION

1. TO BUSINESSMEN.

2. TO Govt. & FINANCE MINISTER.

3. IN INTERNATIONAL TRAD E.

4. TO POLICY MAKERS.

5. TO TRAD E UNIONS.

6. OTHERS ???

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 19/21

U SEFU LNESS IN TH E FOR EIG N T R ADE

PRICE ELASTICITY.

INCOME ELASTICITY.

CROSS ELASTICITY.

PROMOTIONAL ELASTICITY.

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 20/21

Value of the

elasticity

Price rise orcut? What will happen to the quantity demanded? Will totalrevenuerise or fall?

Ed = 0 Price rise The demand curve is vertical, so demand remains the samebut with a higher price.

Rise

(Perfectlyinelastic)

Price cut The demand curve is vertical, so demand remains the samebut with a lower price.

Fall

0 < Ed 1 Price rise The demand curve is relatively steep, so the fall in demandwill be proportionately smaller than the rise in price.

Rise

(Relativelyinelastic)

Price cut The demand curve is relatively steep, so the rise in demandwill be proportionately smaller than the cut in price.

Fall

Ed =1(Unitary

elasticity)

Price rise or aprice cut

The demand curve is a parabola, so the change in price (upor down) will be proportionately the same as the change in

demand.

UnchangedRevenue

1 < Ed < Price rise The demand curve is relatively flat, so the fall in demandwill be proportionately larger than the rise in price.

Fall

(Relativelyelastic)

Price cut The demand curve is relatively flat, so the rise in demandwill be proportionately larger than the cut in price.

Rise

8/8/2019 Unit 3 ME

http://slidepdf.com/reader/full/unit-3-me 21/21

THANKS